RBI Squeezes Money Markets to Spur Selloff in Shorter Bonds
Indian five hundred rupee banknotes are arranged for a photograph in Mumbai, India(Photographer Dhiraj Singh/Bloomberg)

RBI Squeezes Money Markets to Spur Selloff in Shorter Bonds

India’s short-term bond yields and interest rate swaps rose after the central bank took its first small step toward unwinding emergency pandemic measures.

The yield on the most traded 5-year bond rose 10 basis points to 5.20%, while the one-year swap rate rose 15 basis points after the Reserve Bank of India said late Friday it plans to drain liquidity via a reverse repo operation.

The announcement is “a clear signal from the central bank that it wants to slowly start the process of exiting from the extraordinary accommodation that remains in place,” said Kaushik Das, chief economist for India at Deutsche Bank AG. “The central bank wants to nudge the various short-term interest rates to converge to the reverse repo rate gradually.”

RBI Squeezes Money Markets to Spur Selloff in Shorter Bonds

There has been growing consensus among traders that the RBI will start draining excess cash, as surging liquidity caused money-market rates to drop below its interest-rate corridor last year, distorting asset pricing. Still, analysts had only expected it to act possibly in the second quarter of 2021 after the central bank desisted from taking any steps in the December monetary policy.

RBI’s announcement on Friday to retract 2 trillion rupees ($27.3 billion) of banking funds via a 14-day reverse repo operation on Jan. 15 was a surprise, said analysts including those at Citigroup Inc. The bank expects the yield curve to bear-flatten with forecasts for the 10-year yield to stay in the 5.75%-6% range.

The yield on the 5.15% 2025 bond jumped to 5.20%, while the benchmark 10-year yield was up four basis points to 5.92%. Commercial papers maturing in June surged by about 15 basis points while shorter-tenor corporate bonds rose by similar levels, Mumbai-based traders said.

Money-markets rates rose in early trade before settling back. The weighted average call rate was at 3.19% on Monday, largely in line with Friday’s level. The overnight fixing was set 3 basis points higher at 3.48%, according to Financial Benchmark India Ltd. data.

Data in Focus

The RBI’s decision to withdraw excess cash comes after inflation rose quicker than 6% in 11 of the 12 prior readings, hampering its ability to counter the pandemic-driven downturn with rate-cuts. However, data due Tuesday is forecast to show gains in the consumer price index slowing to 5% in December.

“It appears that the high-frequency growth indicators are stabilizing,” Citi economists including Samiran Chakraborty wrote in a note. “These developments could have provided RBI with the comfort to start policy normalization.”

Staggered Approach

Cash in the banking system remains abundant at around 6.5 trillion rupees, according to the Bloomberg Economics India Banking Liquidity Index. Expectations are for a gradual reduction as the economy recovers from a pandemic-induced slump. The RBI would also avoid draining cash in a hurry amid a record government borrowing.

“While it’s too early to get out of the accommodative stance, a staggered approach to normalizing policy will be adopted,” Rini Sen, an economist at Australia and New Zealand Banking Group Ltd. wrote in a note. ANZ now expects no rate cuts in the fiscal year ended March 2022, compared to its earlier call for a 50 basis points reduction.

©2021 Bloomberg L.P.

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