Best emerging-market bonds jolted as India’s RBI drains cash

Central bank doesn’t want to lose control over the price of the money as surging deposits cause short-term rates to fall

Gulf News

New Delhi: Indian sovereign bonds slumped the most in 15 months on concern demand for debt will wane after the central bank announced steps to drain funds from the financial system.

The Reserve Bank of India told lenders to set aside more deposits as reserves as the government’s November 8 move to ban high-denomination currency notes saw citizens rushing to banks to submit or exchange the old bills, flooding them with excess cash. That risked prompting a slide in borrowing costs, threatening to hurt financial stability and stoke inflation in Asia’s third-largest economy.

The yield on government notes due September 2026 jumped nine basis points to 6.32 per cent in Mumbai, according to prices from the RBI’s trading system. That’s the biggest increase in yield for a benchmark 10-year security since August last year. Local sovereign bonds have returned 6.5 per cent in the past three months, the best performance among emerging markets globally, indexes compiled by Bloomberg show.

“The RBI didn’t want to lose control over the price of the money as surging deposits led to short-term rates falling below the benchmark reverse repurchase rate,” said Vivek Rajpal, an interest-rates strategist at Nomura Holdings Inc in Singapore. “The bearish sentiment for bonds may last for a few days.”

The RBI’s weekend move is expected to suck out about Rs3.5 trillion ($51 billion; Dh187.3 billion) from the banking system, according to estimates from the monetary authority. Prime Minister Narendra Modi’s shock currency ban also risked creating a shortage of bonds that central bank needed to manage its money-market operations.

Bonds have rallied this month on speculation increased cash at banks will spur demand for the securities and amid expectations of an interest-rate cut when policymakers’ meet early December. The yield on the debt due September 2026 is still down 47 basis points for November and fell to 6.18 per cent last week, the lowest close for a benchmark 10-year security since April 2009.

“The magnitude of surplus liquidity available with the banking system is expected to increase further in the fortnights ahead,” according to the RBI’s November 26 statement. “In view of this, it has been decided to absorb a part of this surplus liquidity by applying an incremental cash reserve ratio (CRR) as a purely temporary measure.”

The RBI will review the incremental CRR increase once the government issues an adequate quantity of market stabilisation scheme bonds as it has promised, Governor Urjit Patel told the Press Trust of India in an interview.

India’s rupee weakened 0.5 per cent to 68.7750 per dollar in Mumbai, according to prices from local banks compiled by Bloomberg. It sank to a record low last week.

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