RBI squeezes money markets to spur selloff in shorter bonds

India’s key money-market rates and yields on short-term debt rose after the central bank took its first small step toward unwinding emergency pandemic measures.

The weighted interbank call rate rose to 3.44 per cent as against its previous close of 3.18 per cent, while the yield on a five-year bond surged 13 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.”

Bond yieldsBloomberg

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 the central bank’s interest-rate corridor last year, distorting asset pricing. Still, the RBI refrained from doing so in its December review, prompting traders to push back cash tightening bets to the second quarter of 2021.

RBI’s announcement on Friday to retract 2 trillion rupees of banking funds via a 14-day reverse repo operation on Jan. 15 caught many, including Citgroup Inc., by surprise. The bank expects the yield curve to bear-flatten with forecasts for the 10-year yield to stay in the 5.75 per cent-6 per cent range.

The yield on the 5.15 per cent 2025 bond jumped to 5.22 per cent, while the benchmark 10-year yield was up five basis points to 5.92 per cent. The one-month swap rate was eight basis points higher on Monday.

Cash in the banking system remains abundant with around 6.7 trillion rupees, according to the Bloomberg Economics India Banking Liquidity Index.

Data in focus

Consumer price index figures due Tuesday are expected to show a 5 per cent increase in December from a year earlier, returning to the Reserve Bank of India’s target range of 2 per cent to 6 per cent. Prices rose quicker than 6 per cent in 11 of the 12 prior readings, hampering the RBI’s ability to counter the pandemic-driven downturn.

“It appears that the high frequency growth indicators are stabilizing, December CPI is likely to show a sharp correction toward 5 per cent and FY21 fiscal deficit could surprisingly print lower than 7 per cent of GDP,” Citi economists including Samiran Chakraborty wrote in a note. “These developments could have provided RBI with the comfort to start policy normalization.”

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