Over the past year, the Reserve Bank of India has repeatedly spoken about the orderly movement of the government bond yield curve and has taken several steps to ensure that sovereign borrowing costs do not show a sharp increase in the context of the Covid-19 crisis. The levels at which the RBI intervened in the market for much of the past year – both through bond purchases and secondary market intervention – suggested that the central bank was targeting 6 percent as the level of yield for the benchmark government security at 10 years.

Now, however, with the start of the process of normalizing ultra-accommodative monetary policy, the central bank’s tolerance for higher bond yields has increased and the yield on 10-year bonds – the benchmark for a multitude of bond products. credit – could reach 6.50 percent. cent in the short term, said Standard chartered bank Senior rate strategist Nagaraj Kulkarni in an interview with ETMarkets.com. The yield on 10-year bonds stood at 6.33% on Tuesday. Edited excerpts:

The RBI, in its latest policy statement, has so far halted its “GSAP” program while reporting more floating rate repurchase transactions. Do you think this is a signal that the normalization of politics is starting in India?
The RBI used several tools to counter the impact of the COVID-19 shock on the economy and to support domestic growth. Now, the RBI is unwinding some of these extraordinary measures by withdrawing excess interbank liquidity and not committing to buy government bonds in its G-SAP program. We believe these are signals that policy standardization has started. However, the RBI retained the flexibility to renew support should such a need arise.

Short-term bond yields haven’t really risen after the policy statement; is the market a little more confident in the RBI’s normalization policy gradually rather than suddenly?

The RBI has been progressive in its approach and has guided the markets very well; for example, it announced a liquidity withdrawal schedule (via VRRR). This gradual approach should help market players adjust their expectations ahead of important announcements, such as the MPC. Indeed, market participants interpreted the higher threshold for VRRRs since the last week of September as a signal that policy normalization is already underway.

What does the OIS (overnight indexed swap) curve tell us? The 5-year swap is currently around 155 basis points above the repo rate, although the one-year swap still remains at levels plus or minus around 4.06%. What would be a good bet for investors in the OIS market?

We believe that recent price developments in the OIS market are driven by rising global commodity prices (especially crude oil prices) and government bond yields in developed economies (UST, Gilt Yields ). The 1A / 5A segment of the curve is at its highest level since June 2010. The steepening of the OIS curve indicates market expectations for further normalization of monetary policy. We expect such a slope to persist until the RBI begins to accelerate its normalization, after which we expect the curve to flatten out.

How confident are you about the inclusion of the bond index in the current fiscal year? What order of flow do you expect if it were to materialize this year? What are the challenges involved in facilitating the process?

Discussions about including Indian Government Bonds (IGBs) in some key global bond indices are not new. After debt market reforms are completed, global investors typically need a few months to assess the market before recommending inclusion. For inclusion to happen this year, we believe the Indian authorities need to speed up the process of easing operational issues faced by investors. Otherwise, the inclusion of IGA may be delayed beyond the current fiscal year.

We expect Indian government bonds in the Fully Accessible Roads (FAR) category to be considered for inclusion in major global bond indices. If inclusion were to occur, we would expect inflows of between $ 35 billion to $ 45 billion ($ 35 billion to $ 45 billion) over the next 12 months.

Index providers have predefined criteria for inclusion in their indexes. The most important criteria for the inclusion of GBIs are: (1) global investors should be able to access the market without any constraints (quotas); (2) the operational investment process must be fluid. By introducing the FAR category, the authorities may have addressed point 1 above, but global investors are not yet convinced of point 2. To overcome the operational problems faced by global investors, IGBs investable through FAR can be made eligible for settlement via International Central. Securities depositories, in particular Euroclear. Global investors are familiar with such settlement processes. Although settlement in Euroclear is neither a necessary nor sufficient condition for inclusion in the index, in the case of IGBs, we believe settlement in Euroclear will address point 2 above. This should pave the way for inclusion in the index.

Does the current level of the benchmark 10-year yield take sufficient account of the situation on the tax / interest rate front? Has the RBI given tacit acceptance of higher interest rates by allowing it to exceed the 6.30% level (compared to the strong central bank intervention seen last year in the management of yields).

We believe the new equilibrium in 10-year IGB yields is above 6.30% – we estimate around 6.50% in the short term. Compared to the recent past, the RBI has become increasingly comfortable with adjusting IGB yields upward. We believe this is also part of standardization.

What is your timeline for a possible interest rate hike? Where do you see the repo and reverse repo rate, say, 6 months down the road?

Assuming there are no further growth shocks, we expect the RBI to raise the repo rate by 40 basis points between the policy meetings in December 2021 and February 2022. We expect that the repo rate will be raised from August 2022, although there is a risk of an earlier rise if growth picks up faster than expected or if inflation defies the downward path of the MPC of a gradual move towards the medium term target of 4%.


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