Surprising market participants, the Reserve Bank of India announced a 25 basis points rate cut on Friday, December 5, bringing the repo rate to 5.25%. The central bank also maintained a “neutral” policy stance, which indicates it is ready to move rates up or down in the upcoming policy decisions depending on economic conditions.
Moreover, the central bank also announced an open market operations (OMO) purchase of ₹1 lakh crore in government securities and a three-year USD/INR buy-sell swap of $5 billion in December to inject durable liquidity into the system.
After the policy decision and OMO announcement, India’s benchmark 10-year bond yield slipped by over half a per cent to 6.49% from its previous close of 6.53%.
How rate cuts, OMO affect bond prices, yields
RBI rate cuts reduce interest rates across the economy. This makes existing bonds, which have higher coupon rates as they were issued before the rate cuts, more attractive.
Due to higher coupon rates, the demand for pre-rate cut bonds, or existing bonds, increases, inflating their prices. When bond prices rise, bond yields fall as they have a fundamental inverse relationship.
This is because bonds have fixed interest payments, or coupon rates. For example, if you buy a ₹1,000 bond with a coupon rate of ₹50, your yield is 5%. If the prices of the same bond rise to ₹1,100, due to increased demand, the yield would be 4.54% because coupon rates are fixed. Thus, when bond prices rise, bond yields fall.
Similarly, due to OMO (open market operations) purchases by the RBI, demand for bonds increases, raising their prices and bringing yields lower.
“The announced OMO programme is likely to exert downward pressure on G-sec yields, potentially guiding them toward the 6% level over the course of this financial year,” said Aman Shah, Head of Research, Equirus Family Office.
What should be your bond investment strategy now?
According to Ritesh Taksali, Chief Investment Officer, Edelweiss Life Insurance, bond yields should come down over time as India moves towards a structurally lower interest rate regime. Hence, he believes it is a good time to lock in rates for the long term.
Nikhil Aggarwal, Founder and Group CEO of Grip Invest, said bond yields, across ratings, are expected to move down following the repo rate cut. This aligns with the trend observed after the previous RBI rate cuts earlier this year.
He said investors should look at 12- to 18-month duration papers to lock in the current yields while shielding themselves from potential rate increases over the medium term.
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Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of individual analysts or broking firms, not Mint. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.
