September 17, 2012 / 9:48 AM / 5 years ago

UPDATE 3-Indian bonds end flat on RBI rate disappointment

* 10-yr bond yield at 8.18 pct vs session low of 8.12 pct
    * 1-yr swap rate at 7.71 pct from 7.60 pct earlier in day
    * RBI holds rates, warns on inflation, cuts CRR by 25 bps

 (Updates prices, minor recasts throughout)
    By Archana Narayanan
    MUMBAI, Sept 17 (Reuters) - 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withdrawn after it eased rates," said Robert Prior-Wandesforde,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.

 (Editing by Rafael Nam)

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