RBI's short-term rate cut spurs bond market rally

By Swati Bhat

MUMBAI (Reuters) - The government bonds rallied on Tuesday after the Reserve bank of India (RBI) cut a short-term interest rate, betting that conditions are stable enough to unwind more extraordinary measures taken in July to defend the rupee, which hit a low just over a month ago.

The RBI move late on Monday to cut the marginal standing facility (MSF) rate by half a percentage point to 9 percent follows a 75 basis point cut in the rate last month by new RBI Governor Raghuram Rajan.

Benchmark 10-year bond yields dropped as much as 23 basis points at one point, while overnight index swap rates also plunged. The rupee closed largely unchanged.

Some analysts warn the move is risky. Although the Federal Reserve's decision last month to delay the tapering of its bond stimulus was a temporary reprieve for capital importing countries, strong growth numbers in the U.S. could see the Fed reduce its stimulus and instability reappear in emerging markets.

Although the reduction in the MSF, a short-term rate that banks use to borrow funds, is meant to be another step towards normalising monetary policy, it also contributes to uncertainty about the timing of future moves from the RBI.

The RBI is widely expected to continue cutting the MSF while raising India's main interest rate, the repo rate, by an additional 25 basis points this calendar year after its 25 bps hike last month.

"It's far too premature to believe that the rupee's travails are completely over," J.P.Morgan analysts said in a note to clients on Tuesday.

"Like other emerging markets, India has been the beneficiary of an improving global environment," they noted. "But globally things can often turn on a dime."

The rupee has rallied more than 11 percent since hitting a record low of 68.85 against the dollar on August 28.

Domestic factors have also played a key role in the rebound, including an improving current account deficit outlook, as well as other measures taken by the central bank such as providing a separate window to provide dollars directly to oil companies and measures to attract funds from non-resident Indians.

With Monday's move, the central bank has reduced the MSF rate by a total 125 basis points over the last three weeks after hiking it by 200 bps in mid-July in a bid to curb speculative trading by making short-term borrowing prohibitively expensive.

That move, the most dramatic in a package of measures to defend the currency, saw the MSF rate replace the repo rate as India's de facto policy rate.

Rajan, who took charge over as central bank governor on September 4, said at the policy review on September 20 that the corridor between the repo rate and the MSF would be gradually brought back to 100 bps. It currently stands at 150 bps.

The surprise timing of the move adds uncertainty about how the RBI will bring down MSF rates and raise the repo rate at a time when market participants are already debating the degree the RBI's tightening bias.

For now, analysts say the RBI would be unlikely to raise the MSF rate again in case it renewed instability in the rupee, given the confusing signal it would send about monetary policy aims.

"This is unlikely to be an aggressive policy tightening cycle," said Radhika Rao, economist at DBS in Singapore.

"The RBI is unlikely to resurrect the liquidity measures even if there is another round of rupee volatility. The July moves were largely ineffective in providing outright support to the currency, so by raising the repo rate RBI is also addressing the rate differentials deficit," she added.

Separately, the finance minister said on Monday the government will have to rein in spending and cut subsidies to meet its fiscal deficit target, underlining that an austerity drive will not be blown off course by an election due next year.

The comments, though positive, were overshadowed by the central bank's measures.

The benchmark 10-year bond yield ended down 18 bps at 8.50 percent, although the yield remains up nearly 100 bps since before the mid-July measures.

The one-year overnight indexed swap rate plunged 24 bps to 8.40 percent while the five-year rate closed down 15 bps at 8.11 percent.

(Editing by Eric Meijer and Robert Birsel)

Matches

MORE TOP STORIES TODAY

Rajasthan edge low-scoring thriller

Rajasthan edge low-scoring thriller

The bowlers restricted Hyderabad to 133 for 6 before Rahane and Binny took Rajasthan over the line. More »

Maxwell blitz takes Punjab home

Maxwell blitz takes Punjab home

The Kings XI batsman blasted a 43-ball 95 to help his team pull off a massive chase against Chennai Super Kings. More »

Bangalore vs Mumbai: A battle of the big-hitters

Bangalore vs Mumbai: A battle of the big-hitters

As two of the most glamorous sides in the Indian T20 league, the focus of the match between Mumbai and Bangalore will invariably be on the middle-order… More »

BCCI lacks leaders to take on Srinivasan, says Manohar

BCCI lacks leaders to take on Srinivasan, says Manohar

Two former BCCI presidents, Shashank Manohar and Jagmohan Dalmiya, have reacted strongly to the news of the BCCI calling an emergent meeting on Sunday… More »

Pietersen ridicules idea of day-night Tests

Pietersen ridicules idea of day-night Tests

Kevin Pietersen has ridiculed the idea of day-night Test cricket, saying the game would be so different to proper Test cricket that we will need a whole… More »

Beleaguered Yuvraj tees off to Sharjah's delight

Beleaguered Yuvraj tees off to Sharjah's delight

Yuvraj Singh was hardly convincing to begin with against Delhi, but a big dose of crowd support and a helping of poor bowling meant he had the opportunity… More »

Stressed Trott stands down again

Stressed Trott stands down again

The England and Wales Cricket Board (ECB) on Friday confirmed that batsman Jonathan Trott is to take another break from all cricket with immediate eff… More »

PCB starts another coach hunt

PCB starts another coach hunt

The PCB has decided to not extend the contracts of head coach Moin Khan, fielding coach Shoaib Mohammad and batting consultant Zaheer Abbas, and has invited… More »

Pakistan cricketers face probe

Pakistan cricketers face probe

Pakistani cricket authorities have launched an investigation after a number of current international stars played in exhibition matches in the United States… More »

Fiery star Stokes bids to curb his temper

Fiery star Stokes bids to curb his temper

England all-rounder Ben Stokes admits he must keep his anger under control if he is to end his international exile. More »

Bangalore's arsenal blazes to victory

Bangalore's arsenal blazes to victory

Yuvraj Singh was back to his best in his first match for Royal Challengers Bangalore. More »

BCCI to meet before next court hearing

BCCI to meet before next court hearing

The BCCI will hold an emergent working committee meeting on April 20 to discuss the future course of action with regard to the Supreme Court hearing concerning… More »

Gavaskar wants a clean IPL

Gavaskar wants a clean IPL

"Integrity is non-negotiable..." says the BCCI's interim chief ahead of Season 7 of the tainted league. More »

Time for Chennai to enter familiar cocoon

Time for Chennai to enter familiar cocoon

Chennai have an emphatic 8-3 lead in the head-to-head with Punjab, with one game tied More »

Kallis, Narine star in KKR win

Kallis, Narine star in KKR win

An all-round display saw Knight Riders thump Mumbai Indians by 41 runs in the IPL-7 opener. More »

'Yak' Kallis still on top of his game

'Yak' Kallis still on top of his game

The 38-year-old South African veteran turned it on for Kolkata Knight RIders in the opening match of IPL-7. More »

Rajasthan and Hyderabad face-off

Rajasthan and Hyderabad face-off

A quality that defines Rajasthan and Hyderabad is consistency. Rajasthan was one among two teams to enjoy complete dominance at home last season. Hyderabad… More »

Srinivasan named in fixing report: SC

Srinivasan named in fixing report: SC

The court emphasised that the tainted administrator can no longer work for the BCCI. More »

Yuvraj happy to play for RCB: Kohli

Yuvraj happy to play for RCB: Kohli

New-look RCB will play their first game of IPL-7 on Thursday. More »

IPL: News Line

IPL: News Line

A round-up of all the news from this season of the IPL. More »

Shane Watson issues moral warning

Shane Watson issues moral warning

'Everyone knows what is right and what is wrong and if you do the wrong thing it will be found out' More »

Why I'm not looking forward to the IPL

Why I'm not looking forward to the IPL

Welcome to another season of a league that many watch but few trust. More »

Johnson may quit T20s for Tests

Johnson may quit T20s for Tests

Australia's Mitchell Johnson may quit limited-overs cricket to prolong his test career with an eye on the 2015 Ashes series in England, the fast bowler… More »

Nepal players call off boycott

Nepal players call off boycott

Thaw in relations after formation of an advisory committee that would work in tandem with the Cricket Association of Nepal. More »