NEW DELHI: India’s shorter bonds will likely resume their underperformance against longer peers as tightening liquidity and monetary conditions rein in appetite for the rate-sensitive notes.
The Reserve Bank of India may raise interest rates by as much as 75 basis points in the coming months, adding to a 25-basis-point hike on Oct 7, according to IDFC First Bank Ltd and Deutsche Bank.
The central bank is also absorbing liquidity from the banking system, with excess cash dwindling from a record high in early September.
The impact is visible in the bond market where the gap between the shorter and longer-end yields shrunk to the lowest since May earlier this month, before widening again as crude prices slid.
“Short bonds are more sensitive to immediate interest rate expectations and liquidity conditions,” said VRC Reddy, head of treasury at Karur Vysya Bank.
“I expect such notes to underperform as more rate hikes are still on the cards given how the inflation trajectory is poised.”
Higher short-term yields can raise funding costs for banks and companies, tighten credit conditions and eventually weigh on consumption, investment and economic growth, which has so far showed resilience despite the Middle East war.
The government cancelled a sale of 182-day treasury bills last week as traders likely demanded higher yields.
Cash conditions are expected to remain modest going forward and a drain in liquidity is likely to impinge on deposits where a wedge with credit growth may again open up, according to an Axis Bank research note.
The spread between the five and 10-year yield has narrowed to about 32 basis points from 37 basis points at end-August, according to data compiled by Bloomberg.
IDFC First Bank and Quantum Asset Management Co are among those expecting the curve to flatten more.
Yields on treasury bills, which mature within a year, have also shot up to trade around the highest level in more than a year. — Bloomberg
