Indian financial conditions have begun to tighten once again. Call money rates, bond yields and the rupee have climbed in the past few days.
This hardening of financial conditions comes around a week after the Reserve Bank of India (RBI) cancelled a proposed bond sale because of what it described as the evolving liquidity situation, on the same day that the ratings upgrade by Moody’s Investor Service reduced the risk of holding Indian government bonds. The cancellation of the open market operation as well as the ratings upgrade has helped bond yields ease.
The massive excess liquidity generated in the wake of demonetisation has begun to dry up thanks to some deft handling of the money market by the central bank. However, the reduction in excess liquidity has been happening since around May.
Some of the recent hardening of yields seems to be driven by fears in trading rooms that inflation will breach the central bank’s target. Inflation has been climbing sharply since it hit a low in June—but it is unlikely to go out of control over the medium term.