An Indian five hundred rupee banknote is arranged for a photograph in Mumbai, India. (Photographer: Dhiraj Singh/Bloomberg)

Bonds Advance as India's Central Bank Surprises With Rate Cut

(Bloomberg) -- Sovereign bonds in India rallied after the central bank unexpectedly cut its key rate and dropped its hawkish stance citing easing inflation, providing relief to traders concerned about a record government borrowing program.

The yield on the most-traded 2028 sovereign bond fell seven basis points to 7.50 percent, cooling from 7.57 percent just before the Reserve Bank of India reduced the policy rate for the first time since August 2017. The drop marked a shift in sentiment that had pushed up yields by the most since May last week on concerns about widening in the deficit targets.

“While this is clearly a positive surprise as the RBI acted much quicker than expected, we are somewhat concerned with longer-term fiscal dynamics,” said Eugene Leow, a rates strategist at DBS Bank Ltd. in Singapore. “Higher bond sales across all tenors should cause the curve to shift higher.”

Shorter-end bonds outperformed while the drop in yields on longer-tenor paper was limited on supply concerns. The amount of debt purchases by the central bank beyond February will depend on the evolving liquidity situation, Governor Shaktikanta Das said.

“The front end of the curve should respond to monetary easing expectations, while the longer end continues to reflect premiums owing to the worsening supply-demand equation in bonds,” said Vivek Rajpal, rates strategist at Nomura Holdings Inc. in Singapore.

Bond investors had become skittish about the health of the country’s finances after Prime Minister Narendra Modi’s government on Feb. 1 unveiled a record $100 billion borrowing to bridge a wider-than-expected deficit for the fiscal year starting April 1. The yield on the 2028 bond surged 13 basis points that day, the most in nine months.

Bonds Advance as India's Central Bank Surprises With Rate Cut

The RBI joins its peers including the Reserve Bank of Australia in dialing back their hawkish stance amid subdued inflation and stable currencies. Australian central bank chief Philip Lowe on Wednesday shifted to a neutral policy outlook, acknowledging increased economic risks. The Philippines left its policy rate unchanged on Thursday, following Thailand’s example of standing pat. In Indonesia, the central bank has said the policy rate is close to its peak, and its decision is due on Feb. 21.

India’s inflation slowed to an 18-month low of 2.2 percent in December, well below the RBI’s medium-term target of 4 percent. The central bank sees inflation at 2.8 percent in the final quarter of the fiscal year ending March. Previously, it had projected inflation in a range of 2.7 percent to 3.2 percent in the six months to March.

Still, the policy easing may add to the woes of the Asia’s worst-performing major currency this year, some analysts said. The rupee weakened as much as 0.3 percent per dollar just after the rate decision but soon recovered and rose 0.2 percent to 71.4550 at close.

“I think the markets will view such a policy move as premature and the rupee will be the main victim of this,” said Prakash Sakpal, an economist at ING Groep NV.

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