Bond yields ease amid a surge in liquidity surplus, ahead of RBI’s policy

Yields on the government bonds eased on Tuesday amid a surge in liquidity surplus and ahead of the Reserve Bank of India’s (RBI’s) monetary policy review.

The three-day monetary policy committee (MPC) meeting started on Tuesday.  The panel is expected to keep interest rates unchanged.

The yield of the 10-year benchmark government bond eased 2 basis points (bps) to close at 6.98 per cent. The five-year bond yield also ended 2 bps lower at 6.9 per cent.

“India’s macroeconomic conditions have strengthened substantially over the past few months. Inflation has fallen and the current account dynamics have improved noticeably. Weaker global demand is weighing down most commodity prices while the bulk of earlier supply congestion seems behind us. These also augur well for inflation going forward, even as the upcoming rains will need to be monitored closely. Finally, liquidity conditions have improved markedly over the past few weeks,” said Suyash Choudhary, head (fixed income), Bandhan AMC.

After raising the repo rate by 250 bps to 6.5 per cent between May 2022 and February 2023, the MPC decided to pause in the April review of the monetary policy. RBI Governor Shaktikanta Das emphasised that it was a pause and not a pivot while retaining the possibility of further tightening.

The yield on the 10-year benchmark government bond eased 33 bps in 2023-23.

“Bond yields are reflecting these positives as well as market confidence that India’s rate cycle has peaked. Also, owing to the macro narrative having improved, global bond volatility is no longer transmitting as much to India unlike what was the case for most of last year,” Choudhary said.

Consumer price index-based inflation — the main yardstick for monetary policy making — in April declined to an 18-month low of 4.7 per cent YoY (from 5.7 per cent YoY in March), well within the RBI’s 2-6 per cent target band.

Easing energy cost and due to a favourable base effect, CPI inflation is likely to trend down further in May.

“We expect the moderating trend in CPI inflation to continue in May, and forecast headline inflation at 4.34% y/y, down from 4.7% in April. If realised, it would be almost a two-year low for CPI inflation,” said Rahul Bajoria, MD & Head of EM Asia (ex-China) Economics, Barclays.

The softening headline inflation is likely to prompt the monetary policy committee to maintain the status quo once again in the June policy.

“The MPC will have gained confidence on both the inflation and GDP growth trajectory. A wait-and-watch would work best now with the stance remaining cautious,” said Suvodeep Rakshit, senior Economist, Kotak Institutional Equities. “Overall, we maintain our expectations of a pause from the RBI in the June policy without changing its stance,” Rakshit said.

The RBI has been maintaining the “withdrawal of accommodation” stance of monetary policy since the beginning of the current rate hiking cycle.

One of the reasons why the central bank expected to continue with the withdrawal of the accommodation stance is the rise in the surplus liquidity in the banking system to over Rs 2 trillion.

The surplus liquidity in the banking system was Rs 2.25 on Monday, latest data showed.

The rise in government spending has been one of the main reasons for the surge in the liquidity in the banking system. The RBI’s decision to withdraw the Rs 2,000 denomination bank notes from the circulation has also added to the surplus.