India bonds gain as RBI FX inflows lift liquidity, spur short-term debt buying

Indian government bonds experienced a surge in early trade on Thursday, propelled by the shorter-duration papers. This rise was driven by larger-than-expected dollar inflows under the Reserve Bank of India's special schemes, which increased rupee liquidity and bolstered confidence in Indian assets. The benchmark 6.94% 2036 bond's yield stood at 6.9502% as of 10:30 a.m. IST, following a close at 6.9754% the previous day.

Meanwhile, the five-year 6.36% 2031 bond's yield experienced a slight decline of 8 basis points to 6.48%.

India's attractiveness grew significantly following a $136.38 billion inflow through special foreign-currency mobilization schemes. This influx bolstered the central bank's ability to support the rupee and augmented domestic liquidity. Indian banks had mobilized $127.23 billion through non-resident foreign-currency deposits, with further inflows arriving via external commercial borrowings and overseas foreign-currency borrowings.

Most of these funds would remain in the system for three to five years, potentially spurring demand for five-year securities, particularly from foreign banks with limited retail lending operations, traders suggested.

India's banking system witnessed a liquidity surplus of 9.7 trillion rupees ($102.76 billion), as banks transferred their dollar inflows to the central bank. Kotak Mahindra Bank emphasized that worries about the Reserve Bank of India having to aggressively sterilize the liquidity surplus might be overstated. It anticipates the RBI to rely more on short-term liquidity management tools, such as selling bills with four- to five-month maturities.

However, high oil prices and US Treasury yields continued to dampen demand for longer-dated bonds. The benchmark Brent crude contract remained near $95 per barrel, amid concerns over potential supply disruptions. A sustained increase in energy prices could exacerbate India's inflation outlook and strain government finances.