Indian bond market takes wing hoping RBI answers dovish prayers

MUMBAI: Investors in India's rocketing bond market are betting heavily on the central bank shedding some of its habitual caution by both cutting interest rates and injecting liquidity, but some analysts reckon hopes for further easing are becoming overblown.

Following a suprisingly benign inflation reading for April and what investors interpreted as unexpectedly dovish comments from Reserve Bank of India Governor Duvvuri Subbarao last week, benchmark bond yields have plunged to their lowest since December 2009.

With annual wholesale price inflation dropping below 5 percent and into the central bank's comfort zone for the first time in more than three years, the market expects the RBI to cut its policy repo rate, currently set at 7.25 percent, by a quarter point for a fourth time this year at a policy review on June 17.

It is also expected to carry out open market operations to redress an acute liquidity shortage that partly explains why banks have failed to lower lending rates to companies and consumers by more than they have done, despite the cuts in official rates.

These expectations have translated into a more than 40 basis point fall in ten-year bond yields so far this month, which, if there is no late reversal, would give the market its biggest monthly gain in three years.

But high expectations carry a risk of deep disappointment.

"If the RBI doesn't deliver on these expectations, there is likely to be some sell-off," said Bekxy Kuriakose, head of fixed income at Principal PNB Asset Management. "There doesn't seem to be any reason why RBI shouldn't cut, given the data."

The greater uncertainty appears to hang over how much debt the central bank will be willing to buy through OMOs.

"I don't see the RBI cutting rates and injecting large doses of liquidity at the same time," said a fund manager at a domestic investment house who declined to be identified.

"It is not a very aggressive central bank. And the situation definitely does not warrant such an action."

Consumer price inflation, running at over 9 percent, will have to come down, and India's high fiscal and current account deficits will need to improve before Subbarao is likely to feel comfortable taking aggressive easing measures.