RBI Status Quo On Policy Rate Sends Stocks Lower, Debt Yields Higher

Indian stock markets made a sharp U-turn following the RBI's move to keep the repo rate unchanged. Stocks were trading in the positive zone for most of the day, but dipped 41 points on the Nifty towards the end of trading.

Most bank stocks were trading lower following the RBI's decision while some interest rate sensitive stocks such as auto and real estate also took a knock.

It was widely expected that the RBI would cut rates by 25 basis points at the very least as the demonetization exercise has bought in new cash deposits to the tune of Rs 11.5 crore, which sent yields to 6.2% for the 10-year G-sec.

However, experts continue to expect rate cuts to the tune of 25-50 basis points in the near future.

Says Lakshmi Iyer, Chief Investment Officer (Debt) & Head of Products, Kotak Mutual Fund: "RBI's assessment of Inflation continues to be at 5% by Mar-2017. We believe that CPI inflation would be at around 4.5% by Mar-2017 and thus expect that RBI has a 25-50 bps window for effecting a rate cut in the near future. Were the economy to not perform as per expectation over next 2-3 quarters, the central banker's appetite for rate cut could increase further."

However, the 10-year G-Sec yields spiked to 6.4% following RBI's move to keep rates status quo. Experts point out that the hardening of rates in the global markets may have been a factor in the policy decision. The 10-year US benchmark rate is hovering around 2.4% mark. Says Iyer: "Hardening of yields in most of the developed nations along with forex volatility, may have heightened RBI's risk perception.

The domestic economy's inflation dynamics has not changed due to demonetization and the international hike in crude and depreciation in emerging market currency may have a bearing on inflation in the coming months.

"The assessment on inflation dynamics is hawkish with the RBI indicating that the downside implication for retail inflation out of the demonetization exercise could be limited to only 10-15 bps while there could be upside risks emerging from higher crude oil prices and likely depreciations of EM currencies due to firmer interest rates in the US," said Indranil Pan, Chief Economist, IDFC Bank.

"Dips in inflation could also be restricted from domestic factors too as the core inflation traditionally have remained sticky, while there could be some sustained firmness in food prices other than vegetables. Thus in RBI's assessment, inflation risks are on the higher side while growth risks are balanced."

The next policy meet is scheduled in February 2017, when it is likely that the RBI may cut rates by 25 basis points.