RBI rate cut: Impact on bond market and what it means for bond holders

The Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC), led by newly appointed Governor Sanjay Malhotra, has cut the repo rate by 25 basis points (bps) to 6.25%. The bond market reaction has been mixed, with yields initially rising due to the central bank’s decision to maintain a neutral policy stance and in the absence of new liquidity measures.

This 25-point rate cut has marked the first rate cut in five years. Despite the rate cut, bond yields rose slightly after the announcement, as the RBI retained a neutral stance instead of adopting an accommodative policy.

According to Shriram Ramanathan, CIO, Fixed Income, HSBC Mutual Fund, the market had hoped for a dovish signal or additional liquidity measures, but the RBI’s cautious tone led to a minor uptick in yields.

“The initial reaction of bond markets has been one of disappointment, with yields inching up a few basis points,” Ramanathan noted. However, he remains optimistic that interest rates will soften over the coming months, expecting another 25 bps rate cut in April, which could support the bond market.

Long-term outlook: Lower rates, higher bond prices

From a longer-term perspective, lower interest rates typically lead to higher bond prices, as investors seek to lock in higher yields from existing bonds.

Apurva Sheth, Head of Market Perspectives & Research at SAMCO Securities, explained that the India 10-year bond yields spiked following the rate cut because the market had already priced in the move.“The timing and quantum of further rate cuts will depend on global central banks, particularly the U.S. Federal Reserve, which remains in a wait-and-watch mode. Additionally, the RBI must consider the stability of the ailing rupee, which could restrict further monetary easing,” Sheth added.Also read: Mutual fund experts analyze RBI rate cut: What it means for investors

The RBI also announced the introduction of forward contracts in government securities, expanding the suite of interest rate derivatives available to manage interest rate risks. This move is expected to benefit long-term investors, such as insurance funds, by allowing them to hedge interest rate risk more effectively across economic cycles.

According to Shivaji Thapliyal, Head of Research at YES SECURITIES, this enhancement is crucial for life insurance companies, which frequently provide guaranteed products within their non-participating product basket. Currently, insurers use Forward Rate Agreements (FRA) and partly paid bonds for hedging, and the addition of forward contracts in government securities will further strengthen their risk management capabilities.

Foreign Capital Outflows and Currency Risks Weigh on Bonds

The rate cut is expected to have broader implications on foreign investment in Indian bonds. Umeshkumar Mehta, CIO, SAMCO Mutual Fund, highlighted concerns that a widening gap between U.S. and Indian bond yields could lead to increased capital outflows. With U.S. bond yields rising, Indian debt instruments may become less attractive to foreign investors, putting pressure on the rupee, which is already facing depreciation risks.

“This decision could accelerate capital outflows from India, adding pressure on the rupee, which is already at risk due to global economic uncertainty,” Mehta stated.

The RBI’s balancing act between stimulating economic growth and maintaining currency stability suggests that future rate cuts may be limited unless inflation remains under control.

Also read: RBI’s 25 basis point rate cut aligned with market expectations: Ashwini Kumar Tewari

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)