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Bond turmoil on India’s cash drain shows market fragility

The 3.55% cutoff was closer to the top of the RBI’s interest-rate corridor of 3.35%-4%, raising suspicions that the bank may aim to tighten policy sooner than expected. (MINT_PRINT)Premium
The 3.55% cutoff was closer to the top of the RBI’s interest-rate corridor of 3.35%-4%, raising suspicions that the bank may aim to tighten policy sooner than expected. (MINT_PRINT)

The RBI’s first 14-day reverse-repurchase operation since March saw rates on short-dated sovereign bonds rise as much as 33 basis points over the past week, while average yields on three-year BBB-rated corporate bonds climbed the most since 2018

The Reserve Bank of India’s first steps to revive money-market rates proved how fragile sentiment remains, as a spike in bond yields spurred policy makers to announce more buying to quell the turbulence and protect the economy’s nascent recovery.

The central bank’s first 14-day reverse-repurchase operation since March saw rates on short-dated sovereign bonds rise as much as 33 basis points over the past week, while average yields on three-year BBB-rated corporate bonds climbed the most since 2018. In response, the RBI set up Rs100 billion ($1.37 billion) of sovereign bond purchases for Jan. 21 -- the first direct purchases since October.The market reaction reflects concern about a pullback of central bank support, despite its assurances that policy will remain loose. While a drain of excess liquidity was expected in order to revive money-market rates from their slump late last year, volatility picked up on the RBI’s sudden announcement of Friday’s operation, and intensified on a higher-than-expected cutoff rate.

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The 3.55% cutoff was closer to the top of the the RBI’s interest-rate corridor of 3.35%-4%, raising suspicions that the bank may aim to tighten policy sooner than expected.“The fact that the RBI accepted the entire amount at a much higher rate than the fixed reverse-repo rate is a signal that the central bank is comfortable with higher money-market yields," said Pankaj Pathak, a fixed income fund manager at Quantum Asset Management in Mumbai. “Future operations may see even higher cutoffs, and this will put pressure on short-term bond yields."

The RBI tried to assuage such concerns in a meeting with bank executives on Tuesday, saying that its phased move to normalize liquidity operations wasn’t a withdrawal of its accommodative stance. This latest market turmoil underscores the challenge policy makers face to keep borrowing costs in check amid rising U.S. yields and crude oil, and a budget that is likely to be expansionary.

“The most delicate task in front of policy makers is to ensure that the bond market doesn’t get disrupted because of any communication mishap on the withdrawal of liquidity," said Maneesh Dangi, who oversees $25 billion of debt investments at Aditya Birla Sun Life AMC Ltd. in Mumbai.

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