Indian debt markets witnessed high volatility in the June-Sept-13 period with the shortterm yields hardening up by more than 300 bps. In the same period, the 10-year G-sec rose from 7.16% to touch a high of around 9%.
The genesis of this volatility was in the rising fear of an impending QE3 tapering, which led to a sharp fall in the rupee (a peak to bottom fall of around 18%) against the dollar. It was this tumble in the rupee value which prompted the RBI to tighten the liquidity flow, as also to raise its effective borrowing rate (MSF).
However, the hardening of the yields in the US debt market, and the less than sufficient recovery in the inflation and the US jobs market, have prompted the US Fed to postpone the tapering (into 2014). This has considerably improved the Indian forex and debt market sentiment and also provided time to factor-in the post-tapering effects on various assets. This improvement in the forex and debt market sentiment has allowed the RBI to gradually normalise the policy rates. The operational borrowing rate (MSF) was reduced by around 150 bps in a matter of weeks.
In this period, RBI increased the repo rate in two tranches of 25 bps each to 7.75%. This hike in repo rate was done on account of the rising benchmark inflation (especially due to price rise in food commodities). As a result, the G-sec yield curve has steepened, with the fresh 10- year benchmark finding support at around 8.70% levels. In the money market, most of the T-bills are trading at around 8.80% to 8.90% band.
The debt market appetite seems to be moderate on account of the uncertainty surrounding further repo rate hikes. The discontinuous nature of OMO action by the RBI too does not provide ample comfort to the market. It is apparent that central banker is trying to keep the rupee and the debt market yields in a manageable range, for the time being.
The RBI seems to be waiting for the QE3 tapering schedule to play out, so as to absorb any unforeseen behaviour in the domestic markets. This waiting period may also allow the repo rate hikes and the boosting agri-supply to restrain inflation. Post this play out; RBI may have obtained some room to effect a more growth-oriented policy stance, before the election year budget sets in.