Indian bond prices to rally on RBI’s rate cut expectation

The fall in Indian bond yields is likely to accelerate as market is expecting a 25bps cut in the next policy meeting on next Tuesday. Moreover, pressure on the central bank is mounting for a rate cut, especially after the government stuck to the budget deficit target of 3.5% of GDP for FY17.

Meanwhile, currency, bonds and debt markets are closed today on account of banks' annual closing of accounts.

This is consistent with the assessment that recent Indian economic data have improved a bit -CPI inflation moderated to 5.2% y/y in February from 5.7% y/y in January. However, given that service sector inflation remains high, it will be important to assess the tone of the monetary policy statement, as we believe that there are upside risks to the RBI's FY17 inflation target of 5%.

For the bond rally to sustain, bankers said that a rate cut by the RBI on 5 April would not be enough as such a move has already been priced in. In fact, a section of the market expects a deeper 50 basis point cut in the repo rate. The central bank would have to indicate that systemic liquidity deficit would be addressed and that it would use all instruments to infuse liquidity.

“Bankers expect yields to fall by 15-20 basis points over the next one month. “There is still steam left in the bond rally. A fall to 7.25% yield for the 10-year bond is quite possible,” said Sidharth Rath, president-treasury, corporate and transaction banking at Axis Bank.

We foresee that the RBI will primarily focus on the domestic liquidity situation. In the recent week, systemic liquidity has tightened considerably due to the government holding back on spending and maintaining large cash balances with the RBI.