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Bonds Erase Gains in India as Central Bank Signals Tightening

·2 min read

(Bloomberg) -- Most Indian bonds gave up gains after the central bank drained cash from the banking system at a sharply higher rate, stoking fears the monetary authority is stepping up its policy normalization.

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The central bank withdrew liquidity through its 7-day variable rate reverse repo at 3.99%, it said in a statement on Tuesday. That’s 57 basis points higher than the previous auction and just a shade lower than the benchmark policy rate of 4%. Yields rose across the curve after the results, wiping out earlier gains spurred by authorities sticking to the annual borrowing program.

The benchmark 10-year bond yield rose by two basis points to 6.23% on Tuesday after declining to 6.18% earlier. The yield on the 5.63% 2026 bond was at 5.67%, paring the day’s drop to one basis point from seven basis points.

This is the RBI acting proactively, and this is probably a pre-cursor to the policy where the RBI would hike the reverse repo rate,” said Anoop Verma, a bond trader at DCB Bank Ltd. “International crude prices are also going up and this could create a problem with inflation, so they needed to suck out liquidity and ensure things don’t go out of hand.”

The monetary authority has been doing these auctions to modulate liquidity which rose to a record 10 trillion rupees earlier this month, and threatens to weigh on inflation and financial stability. The RBI drained 1.97 trillion rupees ($26.6 billion) through its 7-day reverse repo operation. Weighted average cutoff rate was 3.61%.

The RBI’s withdrawal of liquidity from the banking system has weighed on sovereign debt. The central bank has also started making its bond purchase program liquidity-neutral since last week by including an equivalent sell leg to the auctions.

Earlier in the day, bonds gained after the government refrained from adding to its near-record borrowing plan for the year, bringing some supply relief to the market battered by rising Treasury yields and oil prices.

The administration will adhere to its plan to borrow 12.05 trillion rupees ($163 billion) in the year through March, the finance ministry said in a statement Monday.

The government plans to sell 5.03 trillion rupees of bonds in the six months to March, compared with an earlier plan of 4.8 trillion rupees. The marginal increase is due to the shortfall in the first half borrowing. The second-half borrowing will factor in compensating states for a revenue shortfall caused by the pandemic.

Finance Minister Nirmala Sitharaman had earlier indicated that the government may borrow about 1.6 trillion rupees extra, which led to traders expecting higher sales for the second half.

(Recasts story with variable reverse repo operation result)

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