India Bonds Down As RBI Hikes Rates; Rupee Gains On Rate Gap, Stocks.

Indian government bonds fell Tuesday after the central bank raised one of its key policy rates by more than expected and hinted at keeping cash tight at its quarterly monetary policy review.

The benchmark 7.80% 2020 bond ended at INR100.51, down from Monday's close of INR100.87. The yield rose 5 basis points to 7.72%.

The Reserve Bank of India Tuesday raised its main lending rate, or repurchase rate, by 25 basis points to 5.75%, in line with market estimates, but increased the borrowing, or reverse repurchase, rate by a higher-than-expected 50 basis points to 4.5%, in a bid to curb surging price pressures.

It also raised its March-end inflation forecast to 6% from 5.5%.

All 18 economists surveyed in a Dow Jones Newswires poll had expected a 25-basis-point hike in the reverse repo rate, and 17 expected an equal increase in the repo rate.

Still, caution ahead of what was widely seen as an unpredictable outcome had prompted some traders to exit most of their bond holdings ahead of the policy meet, which limited losses after the announcement.

But the focus remains on the indication that the RBI may prefer the repo rate to be the operative overnight rate, along with the narrowing of the interest rate corridor between the two policy rates.

"The reverse repo hike was higher than expected, but even more alarming for the market was the indication that the RBI may prefer the repo rate to remain the operational rate for a while," said a trader at a foreign bank.

"It is fairly clear by now that the RBI and the government of India are deliberately ensuring tighter liquidity to keep the money in circulation low, and hence trying to keep inflation under control," said Sujoy Das, head of fixed income at Bharti AXA Investment Managers.

This may mean the fixed-income market could be facing higher short-term yields, which could in turn pressure the 10-year bond yield higher, traders said.

In fact, front-end overnight indexed swaps, or OIS, surged on the rate hike, with the one-year OIS trading at 6.10%/6.13% from 5.91%/5.93% last close in a sharp flattening move.

Traders said the front-end rates may remain under pressure, while longer-end swaps may remain relatively unscathed from the upward pressure on rates in the coming sessions.

In the currency market, the Indian rupee surged against the U.S. dollar as a growing interest-rate differential, an upbeat euro and buoyant stocks supported the local unit.

The dollar fell to INR46.66 in late trade Tuesday from INR47.06 late Monday.

"Today's hike pushed up the rate differential between India and the advanced economies, while local stocks, which typically fall with rate hikes, stayed supported," said a trader at a private bank. "It was pretty much the best-case scenario for the rupee."

The Bombay Stock Exchange's Sensitive Index gained 0.3% to close at 18,077.61, after trading between 17,998.74 and 18,149.56.

However foreign funds may be wary of chasing debt despite the higher yields in India, said Sean Callow, foreign currency strategist at Westpac Institutional Bank.

"Moody's upgrade of India's rupee debt this week is an obvious positive, but accelerating growth and inflation are hardly the recipe for a bond rally," Callow said in a research note.

Source : online.wsj.com