MUMBAI: Indian bonds ended flat on Monday, wiping out earlier gains after the central bank kept interest rates on hold and retained its focus on inflation, dashing hopes for a change in stance after the government announced a slew of policy reforms.
The 10-year bond yield had slumped to nearly an eight-week low in early trade on hopes the government's big bang reforms last week -- including raising diesel prices and attracting foreign direct investment -- would spur the central bank to respond by cutting interest rates.
Instead, the Reserve Bank of India opted to cut the cash reserve ratio, which may prompt the central bank to delay bond buybacks that investors had expected starting this month given the liquidity drain from tax payments.
The central bank's continued warnings on inflation also raised some doubt about the timing of any future rate cuts, even after the government made clear it wants such an action at the RBI's policy review in October.
"The recent measures taken by the government are necessary for the economy, but probably not sufficient for a rate cut. And in any case, the last thing the RBI wanted is the measures being withdrawn after it eased rates," said Robert Prior-Wandesforde, Asian economic research director for Credit Suisse.
"We think there is a slightly more than 50 percent chance of a 50 basis point cut in the repo rate in October."
The benchmark 10-year bond yield was unchanged at 8.18 percent, after earlier falling to a session low of 8.12 percent, near the July 26 low of 8.10 percent touched on Friday.
Yields had dropped initially after the government opened up the retail and aviation sectors for foreign direct investment on Friday, following up on its steep hike of diesel prices on Thursday.
Investors had hoped the measures would be enough to spur the central bank to cut rates, given RBI officials have repeatedly called on the government to deliver fiscal reforms before considering monetary easing.
The RBI did cut the cash reserve ratio by 25 bps on Monday, a move that is seen injecting 170 billion rupees of cash into the banking system ahead of expected liquidity tightness due to advance tax payments and festival-season demand for cash.
Still, analysts said the central bank would likely need to continue managing liquidity via open market operations
"In the near term, this (CRR cut) will reduce the need for OMOs, but in the medium term the RBI still has to inject more than 1 trillion of primary liquidity and bulk of which will be done via OMOs" said Kumar Rachapudi, fixed income strategist at Barclays Capital in Singapore.
The 1-year OIS rate, which is a close barometer of near-term rate expectations, fell 2 bps to 7.71 percent for the day, although that was a steep reversal from the session low of 7.60 percent hit in early trade.
The 5-year OIS fell 1 bp to 7.20 percent after opening at around 7.12 percent.
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