India’s 10-year benchmark bond yield sprinted to 7.96 per cent — its highest in three years — on Thursday after the Reserve Bank upped the benchmark rate by 25 basis points.
The bond yield was last seen at the same level in May 2015.
The RBI brought the rate hike cycle back on Wednesday as the decision was unanimous. Repo is the rate at which the central bank lends to banks, which now stands at 6.25 per cent. Interestingly, the RBI kept its stance neutral.
Reverse repo, the rate at which the apex bank borrows from banks, also went up by a similar proportion to 6 per cent.
Lakshmi Iyer, CIO (Debt) & Head – Products, Kotak Mutual Fund, said, “While the rate hike was a largely discounted event, the increase from 11 per cent to 13 per cent SLR for LCR purposes, comes a potential demand deterrent for G-secs. With no great triggers for yields to ease, we could expect long bond yields to remain at elevated levels… We could expect some easing at shorter end of the yield curve. Prudence demands to stay at short end of the yield curve and continue to favour accruals over duration.”
This was the first increase in interest rate since January 28, 2014, when rates were hiked by a similar proportion to 8 per cent.
In the wake of continuing rise in bond yields, the Reserve Bank on Wednesday allowed banks to spread their mark-to-market (MTM) losses for the June quarter as well.
In April, the RBI had given banks an option to spread provisioning for MTM losses recorded on their investment portfolio during the quarters to December 2017 and March 2018.
The central bank had also asked banks to build an Investment Fluctuation Reserve (IFR) of 2 per cent of their holdings in the Available for sale (AFS) and Held for Trading (HFT) categories to build up adequate reserves to protect against increase in yields in future.
Arvind Chari, Head – Fixed Income & Alternatives, Quantum Advisors, said, “Bond markets have already priced a 50 basis point rate hike and thus, we do not see much impact on bond yields from this rate hike. The risk we see is from the stance of the policy, the RBI has retained stance at neutral which keeps it data dependent. We believe that if CPI trends towards 5 per cent, the stance may be changed to tightening, which then brings in market uncertainty on whether this will be a larger rate hiking cycle of 75-100 bps.”
Chari added: “We differ with the RBI on its assessment of liquidity. Weighted average call rates (decided by the banks) cannot be the only parameter of judging liquidity conditions. Money market rate, which is reflective of the entire bond market participation, is signalling tighter conditions and asymmetric liquidity situation.”