India's central bank is stepping up its liquidity fight with its biggest cash-absorption move so far: selling 1 trillion rupees of bonds to pull money out of the banking system. The timing is pointed. Markets were shut Monday for a holiday, and analysts expect the added supply to push government borrowing costs higher when trading resumes Tuesday, after yields already climbed Friday in line with global moves.
Hours before the plan was unveiled, Governor Sanjay Malhotra noted the RBI had ample tools to drain liquidity. Traders had been braced for something along these lines as surplus cash with banks climbed to a record near 11 trillion rupees, fueled by large inflows under recent capital-raising windows.
The central bank will split the program across three dates: Sept. 17, Sept. 21 and Sept. 28. For the Sept. 17 auction, the RBI put up for sale bonds that mature in 2029 through 2032. Extra supply typically pressures prices and lifts yields, and ICICI Securities Primary Dealership economist Abhishek Upadhyay said, "The 10-year yield could rise by around 10 basis points, with an even sharper rise possible in the shorter-tenures." He added, "The market's fear is that more such measures will be announced, given the scale of the liquidity surplus."
Up to now, the RBI has leaned on variable-rate reverse repo operations of as long as one month to temporarily park excess cash. Those drains unwind quickly and have not been effective at nudging funding costs higher.
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The RBI has plenty of bonds to deploy. According to Citigroup, the RBI's portfolio expanded by over 40% during the previous fiscal year, reaching roughly 23 trillion rupees, which amounts to about 18% of outstanding central government securities - well above typical levels, the bank noted.
Why all the cash? Initiatives aimed at drawing foreign-currency deposits from the Indian diaspora raised a record $127 billion, leading authorities to shut the window a month earlier than planned in August. When you add in concessional foreign-currency loans raised by banks and government-owned companies, the haul from these programs reached $136.4 billion.
Ample liquidity has pushed the overnight interbank benchmark that guides policy, known as the weighted average call rate, to levels clearly below the RBI's policy rate, thereby loosening financial conditions even as higher crude prices threaten inflation. Minutes from the August meeting indicated policymakers were already inclined toward tighter policy, and with oil up since then, the risk case has only grown. Puneet Pal, who heads the fixed-income desk at PGIM India Mutual Fund, said the flood of funds has skewed money markets by keeping borrowing costs too low and needs to be addressed.
Circle Oct. 7 on the calendar. That is the next policy decision, and economists, including at Citi, say a rate hike is possible. For everyday investors, this points to a period where government bond yields and short-term rates could drift higher as the RBI swaps short-lived drains for chunkier bond sales.
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