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Informist, Friday, May 23, 2025

 

By Aaryan Khanna

 

NEW DELHI – The Reserve Bank of India generated enough of a surplus in 2024-25 (Apr-Mar) that it managed to announce a record transfer to the government while raising its risk buffers. To the bond market, however, the number came up short against weighty expectations.

 

The record transfer of INR 2.69 trillion for FY25 was higher than what the government had budgeted as income from the RBI's transfer and the dividends of state-owned banks in the current fiscal, at INR 2.56 trillion. However, traders had piled bonds into their portfolios hoping for a number in excess of INR 3 trillion, and will now have to deal with a figure at the lower end of the expected range of INR 2.5 trillion–INR 3.5 trillion. The central bank's board raised its contingent risk buffer for FY25 by 100 basis points to 7.50%, pinching a little over INR 760 billion from the government's kitty to its own buffers.

 

Saved by the bell on Friday--the RBI released details of the surplus transfer minutes after government bond trading closed--the sell-off on Monday and beyond is expected to be led by short-term bonds, which had a stellar week leading up the announcement. Traders had already gorged on gilts maturing in under five years, hoping for a profitable exit after the announcement. Instead, these bonds are unlikely to find favour in the next few days as prices correct, with hopes of buybacks or borrowing cuts fading. Cut-off yields at the government's Treasury bill auction this week had dropped to a three-year low expecting the boost to the cash balances would lead to lower supply of the sub-one-year debt instruments. 

 

"The market had started looking at a figure around INR 1 trillion above the budgeted amount," said Vijay Sharma, senior executive vice-president at PNB Gilts. "So the number is around INR 400 billion less than what gilts had priced in, and that will impact traders' considerations of borrowing cuts or buybacks going ahead."

 

The spread on the 10-year 6.33%, 2035 bond over the two-year benchmark 7.38%, 2027 gilt--which was at 47 basis points on Friday--may flatten by around 7 bps over the next week, dealers said. However, the disappointment will be brief and not very significant in the overall scheme of things, considering the case for a steep yield curve persists, with at least another 50 bps of repo rate cuts expected by the RBI's Monetary Policy Committee. 

 

Moreover, the central exchequer will still be richer by a whopping INR 2.69 trillion at the end of the month. The durable, or core liquidity surplus, is expected to touch INR 5.5 trillion by early June, the largest excess since July 2022. Banking system liquidity will also bounce back to a surplus of around INR 2.5 trillion by May-end, a little over 1% of banks' net demand and time liabilities, from around INR 1 trillion on Thursday.

 

As the government spends the newfound cash, overnight rates are expected to slip below the Standing Deposit Facility rate, which is 25 bps below the policy repo rate, and sustain there. Still, traders will have the constant refrain that by retaining an additional buffer, the RBI has curtailed the government's hand this year in either spending to aid slowing growth or slashing its borrowing.

 

"The transfer will still translate to heavy banking system liquidity as soon as the government spends," said Madhavi Arora, chief economist at Emkay Global Financial Services. "As of now, we do not expect Centre's fiscal math to change dramatically owing to this. The additional amount from the Budget will partly offset other shortfalls on heads such as tax revenue. Thus, as of now we are not expecting any borrowing cuts in dated papers this fiscal (year)."

 

With the event out of the way, the mismatch between government bond demand and supply may now have peaked. The RBI had frontloaded its liquidity injection, and has bought over INR 5 trillion worth of gilts through open market operations so far in 2025, leading to a negative net supply of gilts as of Friday. Though further RBI purchases are expected this financial year, members of the Fixed Income Money Market and Derivatives Association of India last week said they were comfortable if the central bank took a breather and allowed some supply to come through to investors. A rather dormant period of no RBI or government gilt purchases is now expected for the next few months, dealers said.

 

With the 10-year benchmark yield already around 35 bps lower than March-end, traders said they would rely on further gains from the confluence of easy liquidity and rate cuts. Since 50 bps of further rate cuts have largely been priced in, traders expect the 10-year yield to gain only by another 15-25 bps till it touches 6.00% by September or December-end, dealers said. Having lost on some of the bounty from the surplus transfer, investors may make outsize gains again only if the market's expectation of the terminal repo rate falls below the current 5.50%.

 

"The number on the surplus transfer is not going to be a big positive or a big negative for the market, in a material sense," said Dwijendra Srivastava, executive vice president and chief investment officer – debt at Sundaram Asset Management Co. "But considering how far the rally has gone, the margin of safety in gilts is reducing, especially as the reduction in rates will come to an end in the next few months."  End

 

Edited by Akul Nishant Akhoury

 

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