RBI policy: Why repo rate cut failed to cheer

While rate cut of 25 bps was in line with consensus estimates, it was below bond market’s expectations.

BCCL
It will be difficult to satisfy the never ending demands of the markets. The negative reactions coming from both equity and debt markets after the latest rate cut by RBI reinforce this truth. RBI on 4 October reduced repo rate by 25 basis points (100 basis points constitute 1 percentage point). Bond prices fell after the announcement and 10-year yield moved up by 80 basis points (bond prices and yields move in opposite directions). Similarly, benchmark equity indices Sensex and Nifty fell by 1.14% and 1.23% respectively.

The stock market’s negative reaction to the sudden 80 bps reduction in growth estimates was on expected lines. For example, RBI has reduced the projected 2019-20 growth rate from 6.9% in August to 6.1% in October. With global growth threatened, experts have started doubting if this 6.1% is achievable. “Based on recent signs of local and global slowdown, even this revised expectation of 6.1% may be disappointed,” says Suyash Choudhary, Head – Fixed Income, IDFC AMC.

Faltering growth and inflation under control should have been good news for the debt market, but why did it react negatively? The overall tone of the the policy was also dovish indicating an increased probability of further rate cuts in future policy meets, if growth estimates fall further.


First, the 25 bps cut was below expectation for some market participants. “While the repo rate cut of 25 bps was in line with consensus estimates, it was below the expectation of the bond market bulls,” says Mihir Vora, CIO, Max Life Insurance. Debt market participants were expecting a bigger cut because of visible global slowdown (ie Purchase Manager Index data in developed market has gone below 50, which indicates economic contraction in those countries).

The 10-year yield and repo rates moving in different directions is not a new thing. For example, the RBI reduced repo rates by 60 bps during the last two months, but the 10-year yield went up 30 bps during same time.

Debt market’s concern with fiscal slippage which is due to the massive corporate tax reduction announced by the Finance Minister, is the main reason for this. Another worry pertains to states’ financing and consequently increased supply of the state development loans (SDLs). “We are expecting gross SDL supply to touch close to `600,000 crore in the current financial year, almost 30% higher than previous year and as a result, we would expect the yield curve to start to steepen overtime,” says Choudhary.
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