Key Takeaways
- Indian government bonds lost value for the ninth consecutive week.
- Reserve Bank of India's measures to support the rupee have increased bond yields.
- Market expects further tightening to curb capital outflows and preserve rupee value.
Indian government bonds have experienced a ninth consecutive weekly loss, driven by the Reserve Bank of India’s (RBI) aggressive measures to support the rupee. The benchmark 6.94% 2036 bond yield rose by approximately 8 basis points this week to 7.3789%, marking a significant 62 basis points increase over nine weeks.
The RBI intensified its efforts to support the rupee this week, including doubling down on rupee defence and draining excess liquidity through open-market sales. These actions have dampened market sentiment and contributed to the bond yield increases.
Higher inflation and the RBI’s efforts to curb the rupee’s decline have heightened expectations of a larger December rate hike. The yield on the 6.36% 2031 note has risen by 18 basis points this week, reflecting the broader trend of rising yields.
RBI Governor said on Tuesday that while the central bank does not typically use monetary policy to safeguard financial stability, the two are not fully separable. This suggests that inflation is no longer the sole driver of monetary policy decisions. Nomura noted that if global conditions remain stressed, the RBI may announce additional measures against speculation and targeting balance of payments (BOP) flows.
Sources and analysts told Reuters that the RBI is expected to further tighten financial conditions to stem capital outflows and raise the cost of shorting the rupee. Traders are also concerned that the RBI may allow higher bond yields to maintain a spread over US rates, with the 10-year yield premium widening to 227 basis points this week from 206 basis points the previous week.
The market faces additional challenges from the central and state governments' borrowing calendars, which are duration-heavy. Easing US Treasury yields provided some relief, with the 10-year yield down over 13 basis points this week to 5.11%, marking its best week since the Iran war began in February.
The RBI’s overnight indexed swap (OIS) curve flattened sharply, with the 1-year rate posting its biggest weekly rise this financial year. The one-year OIS rose by 32 basis points to 6.56%; the 2-year surged by 18 basis points to 6.6225%; and the 5-year added 6 basis points to 6.7875%.
