Indian government bond yields are anticipated to rise in early trading today, influenced by the Reserve Bank of India's (RBI) recent announcement of another liquidity withdrawal operation, which has weakened market sentiment and suggests policymakers are anticipating higher overnight rates.
RBI's Liquidity Management
The RBI is set to conduct a three-day variable rate reverse repo auction (VRRR) for 1 trillion rupees ($11.63 billion). This action follows a prior withdrawal of 1.52 trillion rupees from the banking system on Friday through a seven-day VRRR. These operations are part of the RBI's strategy to manage liquidity by using repo and reverse repo operations to inject and withdraw funds, respectively.
The weighted average interbank call money rate is currently at 5.31%, while the weighted average tri-party repo (TREPS) rate has decreased to 5.19%, a drop of 11 basis points from the previous session. The current strategy of the RBI involves consecutive weeks of shorter duration VRRR.
Market Impact and Expert Views
A trader at a private bank anticipates that the yield on the benchmark 10-year bond will likely fluctuate between 6.30% and 6.33%. This forecast follows the bond's previous close at 6.3163% on Monday. The five-year 6.75% 2029 bond concluded at 6.0025%. Another trader noted that the RBI's consistent use of shorter duration reverse repos indicates a clear intent to maintain overnight rates within the monetary policy corridor. Some traders believe the timing of the move has disrupted market sentiment, leading to potential sell-offs in shorter-term bonds, with treasury bill yields possibly adjusting by as much as 10 basis points.
On July 9, 2025, Indian government bonds closed lower due to the central bank's liquidity withdrawal, which dampened investor sentiment. The yield on the 10-year bond ended at 6.3136%, up from 6.3053% the previous day, while the five-year bond yield increased to 5.9704% from 5.9569%. The RBI had withdrawn 973.15 billion rupees ($11.36 billion) through a two-day VRRR, adding to the 1 trillion rupees withdrawn the previous week.
Liquidity Surplus and OIS Rates
Despite tax outflows, India's banking system liquidity surplus has remained high in June, averaging 2.76 trillion rupees per day, which is above 1% of bank deposits. The overnight index swap (OIS) rates are expected to experience paying pressure due to the liquidity withdrawal, while higher U.S. yields could negatively affect the long end of the yield curve. On July 9, 2025, India's OIS rates closed higher, with the one-year OIS rate at 5.53% and the two-year OIS rate at 5.50%.
Broader Economic Context
India's annual retail inflation has decelerated to 2.10% in June, a more than six-year low. This is lower than the 2.5% estimated by economists in a Reuters poll and May's 2.82%. However, core inflation, which excludes volatile food and energy prices, stood at 4.4%-4.5% in June, up from 4.17%-4.20% in May, signaling underlying domestic demand. Brent crude futures saw a rise of 1.4% to $68.10 per barrel, after a 6% decrease in the previous session. The 10-year U.S. Treasury yield was at 4.3023%, while the two-year yield was at 3.7971%.
