Hawkish RBI minutes rattle currency, gilts; rupee plunges to 13-month low

The jubilation over low first-half borrowing was short-lived for the bond market. The 10-year bond yield hit 7.79 per cent in Friday morning trade, a level last seen in February, threatening to undo the entire gains earned since the announcement of light first-half borrowing. 

Bond yields, however, recovered sharply to close at 7.66 per cent, marginally higher than its previous close of 7.63 per cent. The recovery was possible because of heightened buying by nationalised banks, likely as an intervention measure. It was also aided by US President Donald Trump expressing his displeasure at high oil prices, according to bond dealers.

The rupee also fell to a 13-month low of 66.11 a dollar from its previous close of 65.66 a dollar. It came under pressure as foreign investors liquidated their bond stocks, said currency dealers.

Crude oil prices rose to a three-year high of $74 a barrel.

The market was nervous after Reserve Bank of India (RBI) Deputy Governor Viral Acharya gave hints of a policy tightening. The minutes of the meeting turned out to be more hawkish than the policy statement.

Acharya said he was likely to shift towards voting for a “beginning of withdrawal of accommodation in the next MPC meeting in June”. The three main factors cited were “complete closure of the output gap”, “international oil prices at a relatively high level”, and the inflation trajectory remaining above the medium-term retail inflation target of 4 per cent.

“The release of the minutes revives the risk of an earlier-than-expected rate hike,” Morgan Stanley wrote in a report.

Expressing similar sentiment, Nomura said higher commodity prices and the tone of the minutes had increased the probability of rate hikes at upcoming meetings. “Overall, we believe that rate hike expectations have negated the positive impact of lower supply in the bond markets. We expected the 10-year bond to trade below 7.60 per cent, the level at which the supply calendar was announced. However, those levels have retraced as rising oil prices and the RBI minutes have raised the probability of rate hikes,” Nomura wrote.

Already, RBI Executive Director Michael Patra is a vocal proponent of a rate hike. Now, with two of the three members (the other being governor Urjit Patel) from the RBI rooting for a rate hike, it is but a matter of time that rates could head north. And the bond yields reflected that in their movement on Friday.

“The Reserve Bank of India’s policy minutes are increasingly assuming more importance than the policy statement and April proved to be another such month,” said DBS.

The first devolvement (bonds remaining unsold) happened on Friday, with the RBI rejecting bids for Rs 3.98 billion worth of bonds, part of a Rs 120 billion auction. The devolvement happened in a bond maturing in 2020, of which Rs 20 billion was scheduled for auction.

FPIs have been liquidating their bond positions since February. So far this year, FPIs have sold about Rs 43 billion in domestic debt. This selling has pressure on the rupee, which anyway was under pressure as rates normalise in developed economies.

“Recent weakness in the INR reflects its increased sensitivity to global volatility amid rising domestic vulnerabilities. There will likely be risk to global flows in EM and India assets as G4 monetary policies normalise and as geopolitics plays spoilsport on risk assets. This along with a heavy election cycle amid deteriorating domestic macro scenario could be a double whammy for INR,” wrote Kotak Economic Research in a note.