RBI OMO sale fears spur bond sell-off; 10-year G-Sec hits three year high

The benchmark 10-year government security yield in India surged to a three-year high of 7.31% on Friday, driven by growing concerns over persistent inflation, tighter liquidity conditions, and the prospect of additional liquidity-draining measures by the Reserve Bank of India (RBI). The 10-year government security (G-Sec) had started at 7.26% before briefly dipping to 7.25% and then climbing significantly throughout the trading session.

This sharp rise in yields came following a hawkish shift in market expectations after the RBI's monetary policy announcement earlier in the week. RBI officials had warned about heightened inflation risks and indicated that interest rates may need to stay elevated for an extended period. A key factor behind the sell-off was the market's expectation that the RBI would continue aggressively selling government securities through open market operations (OMO), which could total around ₹1 lakh crore in the coming weeks.

Rajeev Pawar, Head of Treasury at Ujjivan Small Finance Bank, noted that the market had long been comfortable with surplus liquidity of around ₹3-4 lakh crore remaining in the system, but now anticipates a larger withdrawal of liquidity than previously expected. V Rama Chandra Reddy, Head of Treasury at Karur Vysya Bank, added that the combination of elevated inflation expectations and additional OMO sales has contributed to persistent hardening in yields.

The shift in the bond market has intensified since RBI Governor Sanjay Malhotra ruled out rate cuts and suggested that inflation pressures could remain elevated in the months ahead. While the initial consensus was that the repo rate would peak between 5.75% and 6%, the market now forecasts a terminal rate of up to 6.25% by the end of fiscal year 2027, representing a cumulative tightening of up to 100 basis points from current levels.