The post-policy bond market

WEEK AFTER the credit policy was announced on June 6, the financial markets looked quite different from what was expected.

- MADAN SABNAVIS

Normally when the Reserve Bank of India (RBI) lowers the repo rate there is unbridled enthusiasm with bond yields going down. The talk then centres on how soon banks will transmit the repo rate cuts.

This time the RBI had provided not just a rate cut of 50 basis points (bps)—generally more than what was expected—but also lowered the cash reserve ratio (CRR) at a time when the system was in a surplus of almost ₹2.5-3 lakh crore on a daily basis. At first sight, this would sound odd as providing liquidity when it was already in surplus would not have made any sense.

However, on deeper thought, the RBI has added certainty in the market by announcing the cut over four tranches post-September. This would also be the beginning of the busy season when demand for credit picks up. Therefore, the rate cut and the reduction in CRR are to be viewed more as a set of measures to tell the markets that the RBI would be providing full support to the system. In fact, it also signaled that the focus would be on growth from now on as inflation is well under control with the annual rate expected to be 3.7%.

This was probably a new approach taken by the RBI, which is refreshing as it blended certainty with surprise. The surprise element was the big-bang impetus of a dual boost through repo rate and CRR cuts. The market should ideally have applauded with bond yields going down. In fact, the 10-year bond should have gone to the 6.15-6.20% level but instead has now gotten into the 6.30%-plus range (going by both the new and old benchmarks). Why should this be so?