Traders brace for prolonged India bond slump as RBI mops up excess cash

Bond traders expect yields to rise as the RBI drains excess liquidity amid higher oil prices, rising inflation and heavy government debt supply

A sense of unease is gripping India’s bond traders as they fear the central bank’s push to drain excess cash from the financial system, just as inflation picks up and a global debt selloff intensifies, will spark an extended slump.

ICICI Securities Primary Dealership Ltd., one of the nation’s largest underwriters of government debt, and IDFC First Bank Ltd. are among those predicting the benchmark 10-year yield to potentially surpass the 2026 peak hit in May and climb as high as 7.25% by Dec. 31. That would be the highest level in three years. Citigroup Inc. has brought forward its expectation for an interest-rate hike by the Reserve Bank of India to October from December.

It’s a sharp reversal in sentiment. Just last month, the central bank drew a record $127 billion from India’s diaspora through special deposits as it sought to bolster its foreign-exchange reserves and defend the rupee. The inflows, which surpassed even the RBI’s own estimates, pushed the banking system’s cash surplus to an all-time high of about ₹11 trillion ($115 billion), helping cushion local bonds as yields in major markets surged to multiyear highs.

But with the liquidity glut and a renewed surge in oil prices intensifying inflation risks, the RBI has sprung into action. Its plan to drain ₹1 trillion from lenders through open-market bond sales sent yields surging across the curve on Tuesday, with the 10-year rate now at 7.08%. Markets are bracing for more such measures in the weeks and months ahead.