India’s bond market volatility surged as supply fears collided with RBI liquidity measures, forcing investors to reassess yields and borrowing risks. The Indian government’s bonds were highly volatile this week, with investor concerns about the massive debt pipeline and the Reserve Bank of India’s (RBI) drastic measures to fight for control. Both the central government and the states’ borrowing estimates combined for a potential record of £30 trillion. It is now leading to fears that supply will hinder the RBI’s ability to stabilise the Rupee and anchor Interest Rates. Also, there is no Demand for investment because Deposits have seen little to no growth, and liquidity has been very constrained. Liquidity support has temporarily stabilised the India bond market.
Despite the RBI’s aggressive initiatives before this week (bond purchases, foreign exchange swaps, etc.), the yields on Bonds remained at a very elevated level. Two causes affected the price of Bonds during this period: 1) banks were hindered in purchasing additional Bonds due to regulations, so they chose to invest in higher-yielding state debt instead; 2) Insurers and pension funds pulled back on their investment in Bonds. Finally, the drain of Rupee liquidity by the RBI’s intervention in the currency market has also affected the supply/demand of Bonds. The result is that the 10-Year Bond Yield reached nearly 6.72%, the highest level in 11 months, while the money market rates remain higher than the Policy Rate of the RBI.
RBI steps in to calm India bond market volatility
After announcing almost ₹2.90 trillion in additional liquidity, the mood transitioned. The central bank also confirmed that it intended to purchase ₹2 trillion of government bonds over four separate transactions and complete a ten billion-dollar (USD) / rupee (INR) currency swap. The clarity provided to the market on the purchase of bonds and fears around demand for bond auctions were eased by this action, which immediately instilled confidence in the capital markets.
During the first half of the day, bond prices surged quickly (i.e., an increase in value). As a result, the yield on ten-year government bonds dropped to approximately 6.57%. Traders appreciated the structured plan for bond purchases being established and felt that this gave them more clarity as to what their expectations should be and enhanced positive sentiment.
In addition, according to relevant data over the course of the day, there has been continued buy activity by the Bank in the secondary trading market, which is viewed as very positive and, therefore, should continue supporting demand in the foreseeable future.
Balancing Borrowing and Stability
The RBI’s support has provided some immediate relief; however, there are ongoing challenges ahead. The analysts/market are still forecasting large issuance/borrowing from January through March due to continued high credit-to-deposit ratios and persistent foreign outflows. As such, going forward, the largest challenge will be for the RBI to manage record issuance/borrowing needs while maintaining currency stability and liquidity management; this balance will be one of the key determinants of the direction of future bond yields.
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