Bond yields headed northward, RBI tightens rate corridor

RBI Monetary Policy Status-quo likely but outlook will be key
MPC kept interest rates in the last two policies of FY17 unchanged but changed stance from accommodative to neutral

10 April, 2017

However, it did hike the reverse repo rate by 25 bps to 6 per cent, thereby narrowing the policy rate corridor from 50 bps to 25 bps.

In a separate document, the RBI said it would undertake measures such as additional treasury bill sales, outright open market operations bond sales, or a special facility that would allow the RBI to soak up the liquidity without collateral.

The RBI is also likely to say it continues to monitor global markets as the U.S. Federal Reserve's tightening gives pause to central banks around the world, while dealing at home with a surge in cash at banks after the country's ban on some banknotes past year led to a surge in deposits.

The benchmark 10-year bond yield rose 5 basis points to 6.74 per cent after the MPC decision, but the rupee strengthened to 64.84 from around 64.94 after the RBI kept rates on hold.

However, the experts believed that the central bank is likely to hold the rate tomorrow while unveiling the first bi-monthly review of 2017-18 in view of hardening inflation.

Lowering of policy rate corridor by the RBI, said Yes Bank MD and CEO Rana Kapoor, will ease volatility in liquidity and short-term rates and help in preserving financial stability. "From industry's perspective, greater transmission of previous policy rate cuts and a further softening of the lending rates of banks is important as this would encourage both consumption and investment demand", he added.

Incoming data will determine the future course of action, the governor said at the media briefing in Mumbai after the announcement of the monetary policy, adding that the shift from accommodative to neutral is adequate for now.

The RBI said it is "committed to reverting system liquidity to a position closer to neutrality, consistent with the stance of monetary policy".

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RBI keeps Repo Rate unchanged at 6.25 %, increases Reverse Repo Rate to 6%.

"I think the RBI will wait for a couple of quarters, see how the recovery from demonetisation and the monsoon pans out, see what's happening globally, and then take a call", said Ashutosh Datar, an economist at IIFL Institutional Equities.

On the domestic front, the Central Statistics Office (CSO) released its second advance estimates for 2016-17 on February 28, placing India's real GVA growth at 6.7 per cent for the year, down from 7 per cent in the first advance estimates released on January 6. Considering the quick swings in global macro indicators and volatile political and fiscal set up, upside risks to inflation do remain.

Although Thursday's repo decision had been widely expected, the hike in the reverse repo marked a surprise, continuing a pattern of unexpected decisions at RBI meetings since Urjit Patel became governor in September.

Japanese brokerage Nomura said there can be a one percentage point cut in the cash reserve ratio (CRR) which is the amount of deposits parked with the central bank in the second half of 2017 to tackle the liquidity glut.

"Due to asset quality impacts on banks' balance sheets, there is an overall declining trend in bank credit, primarily towards services sector, industrial segments, and small and medium enterprises", the paper said.

Fourth, the RBI has not quite said anything specific about Non-performing assets (NPAs) but will be coming out with another paper on prompt corrective action which addresses some of the issues.

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