India Central Bank Strikes Hawkish Tone, Fueling Bond Rout

The Reserve Bank of India struck a hawkish policy tone on Friday, saying inflation needs to be tamed and it may take measures to absorb excess cash in the market, sparking a run up in the local bond yields alongside a selloff globally.

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The Reserve Bank of India struck a hawkish policy tone on Friday, saying inflation needs to be tamed and it may take measures to absorb excess cash in the market, sparking a run up in the local bond yields alongside a selloff globally. 

Governor Shaktikanta Das and the rest of his six-member Monetary Policy Committee voted unanimously to keep the benchmark repurchase rate at 6.5%, in line with economists’ forecasts. All but one of the committee members voted to keep the policy stance focused on “withdrawal” of liquidity. 

The jump in India bond yields came alongside worries about surging yields in the US. Treasury yields this week climbed through 5% for the first time since 2007. 

With inflation still well above the 4% target, Das surprised the market by announcing the RBI was considering selling bonds in order to soak up extra cash. That suggests a shift away from using interest rates to liquidity-management tools to control inflation. 

The yield on 10-year notes climbed as much as 15 basis points, the most since August last year, to 7.37% after his comments. Das said there’s no calendar for the bond sales, adding it would take place when necessary.

“Liquidity will remain its preferred way to manage upside inflation risks, rather than tinkering with the policy rate,” Dhiraj Nim and Khoon Goh, economists at Australia & New Zealand Banking Corp., wrote in a note. 

Das emphasized the RBI’s goals, saying “I would like to emphatically reiterate that our inflation target is 4% and not 2%-6%.” He said inflation is still a “major risk to stability, sustainable growth,” highlighting uncertainty around the prices of key food crops. 

What Bloomberg Economics Says…

The Reserve Bank of India conducted what amounts to a stealth rate hike Friday. It held the repo rate unchanged, as expected, but Governor Shaktikanta Das pushed in the direction of tightening by saying that the central bank might sell bonds to mop up surplus liquidity.

Abhishek Gupta, India economist

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India recorded the weakest monsoon rains in five years, with the June-September rainfall about 6% less than the long-term average. A rise in crude prices also doesn’t bode well for India, the world’s third-largest consumer of oil. The RBI’s projections are based on an oil price of $85 a barrel in the second half of the fiscal year. 

“The statement underlines increased vigilance on food inflation and crude oil prices,” said Anubhuti Sahay, an economist at Standard Chartered Plc. “A backdrop of resilient growth domestically implies the repo rate is likely to stay on hold for longer.”

The RBI retained its inflation forecast of 5.4% for the year ending in March, and also kept its outlook for growth unchanged at 6.5%. 

“Only when we are convinced that inflation is at 4% or below on a durable basis, that may call for a rethink” on the policy stance, Das told reporters.

“This is a hawkish pause – replayed,” said Aurodeep Nandi, India economist at Nomura Holdings. Global and domestic uncertainties will dictate that the RBI remains nimble and alert to the risk of higher inflation going ahead, he said. 

The RBI raised its key interest rate by 2.5 percentage points since last year to help rein in inflation and bolster the rupee. The Federal Reserve’s rate hikes and a strong dollar have undermined the rupee and local bonds. However, that pressure may ease in coming months once India is included in JPMorgan & Co.’s emerging market bond index next year, prompting more foreign inflows.  

–With assistance from Kartik Goyal and Ravil Shirodkar.

(Updates with bond reactions)

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