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Informist, Thursday, Jun. 12, 2025

 

By Aaryan Khanna

 

MUMBAI - The five-year benchmark gilt had its worst three-day stretch since September 2022 on fears the Reserve Bank of India would withdraw some of the accommodation it has provided over the past five months. The key concern is that the central bank will do variable rate reverse repo auctions to suck out liquidity temporarily and drive up overnight rates to the level of repo rate.

 

The yield on the 6.75%, 2029 gilt has risen over 18 basis points since Friday to close at 6.00% on Wednesday, its highest closing level in nearly a month. This is the worst stretch for any five-year benchmark bond since 33 months--on the cusp of US Federal Reserve's rate hike cycle that impacted sovereign bond yields across the globe.

 

"The risk is that if the repo rate becomes the operating rate, then the carry that market had bought on will stop making sense," a senior treasury official at a state-owned bank said. "The entirety of the math will have to be reassessed, so it is better to cut your losses immediately, and which is why you're seeing such a sharp reaction in short-term gilts."

 

Over the past three days, the weighted average call money rate and the weighted average triparty repo rate are hovering around the RBI's Standing Deposit Facility rate of 5.25%. RBI Governor Sanjay Malhotra had said at the post-policy press conference on Friday that call market rates would stay around this level unless the central bank conducted VRRRs, through which it could bring the call rate anywhere it wanted depending on the amount. "So we'll see how the situation evolves, and we'll take a call," he had said.

 

The RBI has not conducted a VRRR auction since Nov. 29, with banking system liquidity in a deficit between mid-December and March end. The RBI's blitzkrieg of liquidity since January has been at a historic pace of over INR 9 trillion durably infused over the past five months.

 

The view that low overnight rates will sustain has moved dramatically, though it has been expressed unevenly across markets. Rates on commercial papers and certificates of deposit spiked early in the week by 10-12 bps, while the Treasury bill auction cut-off yields still suggest funding costs will be below the repo rate over the next year. This comes at a time when systemic liquidity surplus is likely to fall to under INR 1 trillion over the next 10 days, a level seen only once since April-end, due to scheduled tax outflows of over INR 2.5 trillion.

 

Traders had bought gilts maturing up to five years after the Monetary Policy Committee outcome on Friday amid expectation these bonds will be in favour and the yield curve will steepen after an unexpected 50-basis-point repo rate cut to 5.50%, dealers said. Risk in these bonds was seen minimal at the time of surplus liquidity, while the demand for long-term bonds collapsed as further rate cuts were not seen with the policy stance at 'neutral'. While long-term bond yields rose on Friday, the five-year gilt yield had fallen 3 bps.

 

Since then, yields across tenures have risen, but bonds maturing in up to five years and the benchmark 2029 gilt have borne the brunt of the selling. Traders hit stop-losses on these bonds on Monday on panic over the potential for overnight rates to move higher, effectively halving the rate cut delivered by the MPC last week to 25 bps. Reuters reported Wednesday that the central bank was looking to anchor overnight rates to the repo rate of 5.50% by conducting VRRRs.

 

"The market has already reacted for the most part (to a potential VRRR announcement), but if the fear comes true, I think there is still a scope for a further sell-off," a dealer at a private bank said. "The market has no certainty of what the RBI wants to achieve with such a move, because it has been reinforcing the message of rate cut transmission that will take a back seat with bond yields reacting so badly." 

 

To be sure, short-term bond yields had fallen much more heading into the June monetary policy review, at the expense of gilts of longer maturities. Some of the correction in the yield has come from traders booking profits as the outlook for gilts has soured and the rate cutting cycle is seen at an abrupt halt. On a closing basis, the spread of the 10-year benchmark gilt yield over the five-year gilt had nearly doubled to 42 bps on policy day on Friday from Apr. 25. That has shrunk to 31 bps Wednesday.

 

While traders are on tenterhooks, awaiting the anticipated announcement, concerns should ease if the notice does not come within the week. The five-year benchmark bond is seen well bid at around 6.10%, as banks will mop up the gilt at a spread 60 bps over the new operative rate, dealers said.  End

 

Edited by Vandana Hingorani

 

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