Indian government bond yields climbed to a three-year high of 7.31% on Friday before settling near 7.30% at close, reflecting mounting market concerns over persistent inflation, tighter liquidity conditions and aggressive liquidity-draining measures by the Reserve Bank of India. According to The Hindu BusinessLine, the benchmark 10-year government security (G-Sec) yield touched 7.31%, its highest level since November 2023, before the bond had opened at 7.26% and briefly eased to 7.25% before climbing sharply through the session. The sharp rise follows a hawkish shift in market expectations after the RBI's monetary policy announcement earlier this week, with investors caught off guard by the central bank's warning on inflation risks and indication that interest rates may need to remain elevated for longer.
A key trigger behind the bond sell-off has been expectations that the RBI will continue aggressively draining surplus liquidity from the banking system through open market operation (OMO) sales. As per The Economic Times, the central bank has announced an OMO sale of ₹25,000 crore on October 13, offering six government securities with maturities ranging from March 2030 to April 2034. The securities include 7.88% GS 2030, 6.10% GS 2031, 7.95% GS 2032, 7.26% GS 2033, 7.18% GS 2033, and 7.10% GS 2034. Rajeev Pawar, Head of Treasury at Ujjivan Small Finance Bank, noted that "The market was comfortable with surplus liquidity of around ₹3-4 lakh crore remaining in the system. The expectation now is that the RBI wants to withdraw more liquidity than earlier anticipated." Given the heavy supply of government bonds and changing liquidity conditions, a gradual move towards 7.5% on the benchmark yield before the next policy meeting remains a possibility.
The Reserve Bank of India delivered its first rate hike in nearly four years, increasing the key policy rate by 25 basis points to 5.50% as part of a strategic shift toward "calibrated tightening" signaling further policy action ahead. According to The Economic Times, the central bank raised the repo rate to 5.50% this week and shifted its policy stance to "calibrated tightening" from neutral, signalling the possibility of further rate hikes. Most economists now expect India's terminal repo rate to reach at least 6.00%, while Standard Chartered Bank and Goldman Sachs forecast the same at 6.25%. Yes Bank said in a note: "The next hike of 25 bps is anticipated for December while cumulative rate hikes are likely at 75-100 bps." However, RBI Governor Sanjay Malhotra ruled out the possibility of rate cuts and indicated that inflation pressures could remain elevated in the coming months, contributing to the repricing in the bond market.
The RBI's liquidity management strategy involves absorbing the current surplus of approximately ₹3.88 lakh crore through various means including currency leakage, liquidity operations, and stricter cash reserve ratio requirements. As per The Economic Times, on October 6, RBI Governor Sanjay Malhotra said the huge banking system liquidity is to be absorbed within the current financial year through various means. The banking system's surplus liquidity has been attributed to heavy mobilisation of FCNR (B) deposits by banks, month-end government expenditure including salaries and pensions, and subsequent swaps with the RBI. V Rama Chandra Reddy, Head of Treasury at Karur Vysya Bank, noted that "Expectations of elevated inflation combined with additional OMO sales have contributed to the persistent hardening in yields." While the general consensus was that the repo rate would to peak between 5.75% and 6%, the market is now pricing in a terminal rate as high as 6.25% by FY27, implying a cumulative tightening of as much as 100 basis points from current levels.
