Indian Bond Yields Fall Amid RBI Rate Cut Speculation

Indian bond yields, particularly the 10-year benchmark bond, have eased by approximately 12 basis points (bps) over the past week. This decline is attributed to optimism surrounding the Reserve Bank of India (RBI) potentially reducing interest rates or the cash reserve ratio (CRR) during its monetary policy review today.

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Bloomberg data indicates that the yield on the 10-year benchmark bond (7.10% 2034) stood at 6.727% on December 5, down from 6.849% on November 28. Similarly, the yield on the 6.79% 2034 bond dropped to 6.678% on December 5, compared to 6.807% a week earlier.

The discussion around rate cuts and CRR adjustments has intensified following a slowdown in GDP growth during the September quarter. The economy expanded by 6.7% in this period, compared to 8.1% in the same quarter last year. This slowdown has reduced the RBI's flexibility to maintain an unchanged policy rate, prompting consideration of measures like a CRR reduction to stimulate growth without fueling inflation.

The CRR, currently set at 4.5%, represents the proportion of a bank's deposits that must be held in reserve with the central bank. It is a critical tool used by the RBI to regulate inflation, control the money supply, and ensure adequate liquidity in the economy.

A report by Nomura anticipates a 25 basis point cut in the repo rate and a 50 bps reduction in the CRR in December. In contrast, a Moneycontrol survey involving 17 economists, bankers, and fund managers suggests that the central bank is likely to maintain the policy rate unchanged for the 11th consecutive time due to higher-than-expected inflation. While most respondents believe the RBI will retain its 'neutral' stance, one predicts a shift towards an 'accommodative' approach.

Bond yields and overnight index swap rates have softened over the past five sessions as investors anticipate policy easing measures in response to India's economic growth slowdown to 5.4% in the July-September quarter—a seven-quarter low.

Gaura Sen Gupta, Chief Economist at IDFC First Bank, commented, "We see higher chances of a rate cut. If the Reserve Bank of India (RBI) opts to maintain the status quo on rates in December, a CRR cut appears more likely."

Sen Gupta further explained that the significant reduction in core liquidity, driven by balance of payments outflows, signals the need for liquidity infusion to align overnight rates closer to the repo rate. This could be achieved through long-term variable rate repos or FX swap auctions.

Market estimates suggest that a 50 basis point cut in the cash reserve ratio (CRR) could inject over 1.1 trillion rupees ($13.00 billion) into the banking system, potentially boosting bond demand.

Following the release of growth data, the 10-year benchmark bond yield declined to a three-year low, while swap rates dropped approximately 20 bps. The spread between the 10-year bond yield and the RBI's key interest rate has narrowed to a seven-year low, signaling an environment conducive to easing.

Meanwhile, domestic traders are monitoring the weekly debt auction, where the government plans to raise ₹300 billion, including funds through a new three-year bond issuance.