The short-end rates are expected to rise further, they added. "I am expecting the government bond yield curve to invert, mainly because of the liquidity tightening, which is impacting the front end," said Pankaj Pathak, fixed income fund manager at Quantum Asset Management.
Yield curve inversion typically signals a recession in advanced economies and, in an economy like India, can signal an impending slowdown. But a liquidity deficit can also temporarily distort the wedge between short-term and long-term rates, as is the case currently in India.
India's banking system liquidity deficit touched a peak of 717 billion rupees ($8.67 billion) earlier in February and will end the month with a daily average deficit of around 63 billion rupees. This is the first time since May 2019 that the system has been in deficit mode on a daily average basis for an entire month.
The two-year government bond yield was at 7.36%, while the more liquid five-year 7.38% 2027 bond yield was at 7.41%.
The benchmark 7.26% 2032 bond yield was at 7.44%, rising 13 bps in three weeks. These narrow spreads could further compress and invert as liquidity remains tight. "Inversion will probably be seen from the one-year government bond (upto the 10-year bond), as core liquidity is drying up very fast," Pathak said.
As liquidity dries up, banks will have to raise deposits at higher costs, which in turn will prompt them to seek higher yields from shorter-term government bonds, he explained. Analysts expect the current inversion to remain at least till March-end.
"The headline liquidity could remain in deficit for most of the days in March on account of frictional factors like quarterly tax outflows," said Vivek Kumar, an economist with QuantEco Research.
GROWTH WORRIES The Reserve Bank of India (RBI) raised the repo rate for the sixth consecutive time, to 6.50%, earlier in the month and kept the door open for more tightening while highlighting core inflation concerns.
Despite inflation rising above the central bank's upper tolerance level of 6% yet again in January, investors are cautious about weakening growth.
"On the growth side, things are kind of plateauing, and we are not seeing any material recovery in consumption demand. At some point, the RBI may have to change its focus and the longer-end will be more anchored to that," Quantum Asset's Pathak said.
India's October-December economic growth data due later in
the day is expected to show a 4.6% year-on-year increase,
according to a Reuters poll of economists.
Earlier this month, two external members of the RBI's
monetary policy committee (MPS), Ashima Goyal and Jayanth Varma,
had said further rate hikes are not needed and the MPC must wait
to assess the impact of its past hikes.
($1 = 82.7450 Indian rupees)
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Movement in Indian government bond yields ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
(Reporting by Dharamraj Dhutia; Editing by Swati Bhat and
Janane Venkatraman)
