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Ahead of the Reserve Bank of India’s RBI monetary policy announcement on Wednesday, bond market dealers are expectedly cautious, though most of them expect the central bank to hike the repo rates by at least 25 basis points. The repo rate is currently at 6% after the RBI cut the rate by 25 basis points in August, 2017. At the time yield was at 6.43%, 140 bps lower than it is now. The benchmark yield closed at 7.83% on Tuesday, four basis points lower than Monday’s closing.

The rupee touched an intra-day low of 67.23 and a high of 67.06, a 16 paisa fluctuation during the same day’s trading session. It closed at 67.15 against the dollar on Tuesday. The anxiety is understandable. Crude oil prices are now ruling at $74.55 per barrel and have risen 47% since June 2017. Food prices could rise, if the government follows through with a generous support scheme for farmers to compensate them for any difference between the MSP and the market price.

If the RBI hikes the repo rate on Wednesday, it will be the first hike in almost four and a half years. The last hike was when the repo rate was increased from 7.75 in December, 2013 to 8% in January, 2014.
Ananth Narayan, professor, SPJIMR, said, there are sufficient reasons for the MPC to opt for a 25 bps rate hike right away, followed by another in August.

“For one, the MPC’s primary focus is on inflation, and core inflation has been steadily increasing. Second, emerging markets like Turkey, Indonesia, Argentina have been in the headlines, and while our situation is not at all comparable, we cannot afford to be seen to be behind the curve. Third, our external sector is looking weak, with rising CAD from higher oil prices, gold and electronics imports, and tepid export performance.

Lastly, the quality of our fiscal deficit has deteriorated, with higher revenue deficits and lower capital spending in FY18. This fiscal trend could continue into this election year as well. Given this overall financial stability context, I believe the MPC will choose to act now,” Narayan said.

While talking about the increasing rates, he added: “Yields across government bonds, corporate bonds, CDs, and CPs have already risen quite sharply over the past nine months or so. A rate hike by itself should not be a surprise to the markets, but the language from the MPC statement will be watched carefully.”

She also said the bond markets have discounted a rate hike which has caused the yields to reach the 7.85% level on Tuesday. “A significant sell off therefore looks unlikely, unless guidance and action both are hawkish,” she explained. A few bond dealers said it is too early for the RBI to increase the rates and there are more factors that have to be considered before they can increase the rates.

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