More elbow room on liquidity tapering: Fuel price cut to help RBI restrain inflation

India’s move to slash automotive-fuel prices last week will likely aid the central bank’s efforts to normalize liquidity flows and restrain inflation, pushing back the timeline for an increase in rates and providing sufficient growth impetus to an economy clambering out of the Covid sinkhole.

As pump prices of transport fuels are reduced, there is a likelihood of lower goods costs, potentially giving the Reserve Bank of India (RBI) sufficient elbow room on liquidity tapering and yet retraining bond yields from spiking as expectations of a change in the rate trajectory are pushed back beyond the latter half of 2022.

Additionally, the US Federal Reserve move last week to taper its bond-buying program could also influence yields globally.


“Local yields are likely to stabilize and trend a tad lower this week as markets resume after the festivities,” said Mahendra Jajoo, CIO- fixed income at Mirae Asset Management. “Mumbai would absorb the muted reaction in global markets to the fed taper and the Diwali gift of lower fuel prices over the extended weekend. It is advantageous for the RBI, which has been doing a balanced job of liquidity normalisation.”

New Delhi last week reduced the excise duties on petrol by Rs 5 a litre and diesel by Rs 10 a litre.

Given the bigger reduction in diesel prices, the greater impact will be on logistics costs, reducing the pace of increase in the cost of consumed goods and potentially trimming inflation by around 15-20 basis points, according to Kotak Mahindra Bank. One basis point is 0.01%.

“The recent pushback to expectations from major central banks and excise duty cuts on petrol and diesel in India should help realign rate-hike expectations,” said Suyash Choudhary, head-fixed income, IDFC Mutual Fund.

On November 3, the US Federal Reserves decided to scale back the bond-purchase programme from this month. The $120-billion-a-month asset purchase programme will be wound up by June next year gradually.

An expected unwinding calendar did not trigger any violent reaction barring a drop in US sovereign yields.

The benchmark US Treasury yields plunged 15 basis points in just two successive trading sessions – Thursday and Friday, both public holidays in India.

The Bank of England, too, held its rates defying popular expectation that it would raise the benchmark.

Back home, the benchmark bond yield increased by about 12 basis points since October with the central bank sucking up excess cash through Variable Reverse Repo Rate (VRRR), a dedicated window.

Treasury Bills, or shorter duration sovereign securities, yielded about 17-28 basis points higher until now since October 6, two days before the RBI announced its bi-monthly policy. T Bills offer a benchmark gauge for short term corporate borrowings.

“The markets have brought forward expectations of policy normalisation in many major markets over the past couple of months,” said Choudhary. “With the recent sharp rise in yields, swaps are now pricing in a hike in effective overnight rate in each policy meeting for the next year.”

The one-year Overnight Indexed Swap (OIS) yield shot up by 31 basis points in October, show data from Financial Benchmarks India.

If global oil prices do not significantly change, elevated market rates are expected to dip now for now, dealers said.

Brent crude oil prices fell over 3.5 percent this month after touching a seven-year high at 85.82 per barrel on October 20.