When the government needs money, it borrows by selling bonds. The “yield” is the interest the government must pay to attract buyers, and it moves opposite to the bond’s price: when buyers get nervous, prices fall and yields rise. The 10-year benchmark bond yielded about 7.47% on Tuesday morning, slightly lower than Monday’s close. It had risen for ten straight weeks through last Friday, the longest such run since 1998.
Several things are pushing yields up. Oil is expensive, the rupee is weak, and traders fear the Reserve Bank of India (RBI), the country’s central bank, will keep raising interest rates. Cash has also become tighter in the banking system, forcing the RBI to step in. Markets are waiting for the US Federal Reserve’s decision on Wednesday.
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ICICI Bank Sees Yields Staying in a Narrow Band
ICICI Bank expects the 10-year yield to trade between 7.40% and 7.60% in the near term, a range that includes Tuesday’s level. It warned that elevated oil prices could weigh on bond prices, which would push yields higher.
Why Banks Are Short of Cash
Banks lend to each other daily, and when cash is scarce, short-term borrowing costs rise. ICICI’s report says the surplus cash in the banking system fell sharply because of GST payments, higher cash reserve requirements, and other factors. It stood at ₹50,000 crore, or 0.2% of the system’s total deposits and similar liabilities, as of October 23.
In response, the RBI has been holding variable-rate repo (VRR) auctions to lend short-term money to banks, including a seven-day operation worth ₹1 lakh crore. Even so, the average rate at which banks borrow from each other overnight rose to 5.70% last week from 5.48% the week before.
ICICI expects these operations to continue. But government spending towards month-end and the maturity of ₹35,400 crore of government securities could put cash back into the system and ease the pressure.
Weak Demand for Government Debt
Demand for government bonds is also soft. At a recent auction by the Centre, the average borrowing cost rose 20 basis points to 7.60%. Demand was weaker than usual: for every rupee on offer, bidders asked for ₹1.90 worth of bonds, compared with a long-term average of ₹2.80. ICICI said this reflects negative market sentiment.
Another test comes later on Tuesday, when state governments auction ₹233 billion (about $2.45 billion) of loans. Both the central and state governments plan heavy borrowing in the coming months.
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Markets Expect More Hikes Than Yes Bank Does
Traders use overnight indexed swaps (OIS) to bet on where interest rates are headed. The one-year rate, at about 6.65%, implies more than 1 percentage point of RBI hikes over the next year. Yes Bank expects half that: 0.5 percentage points, split into 0.25-point increases in December and February. The market may be overreacting, or traders may be preparing for a surprise hike between scheduled meetings, which one fund manager says cannot be ruled out.
Oil, the Rupee, and Inflation: A Vicious Circle
India is the world’s third-largest oil importer, and crude is rising amid the ongoing conflict in West Asia. Brent is around $114.5 a barrel, so India must spend more dollars on imports. That pressures the rupee, which weakened for three straight sessions through Monday and was little changed at 95.22 per dollar on Tuesday. A weaker rupee makes imports costlier, pushing up prices at home, which strengthens the case for RBI hikes and keeps yields high.
The RBI expects consumer inflation to peak at 6% in the October-December quarter, the top of its comfort range. One fund manager said that if crude stays above $100 and the rupee slides towards 96 per dollar, a surprise hike cannot be ruled out.
What to Watch Next
The state-loan auction later on Tuesday will show whether investors are willing to lend for the long term. Month-end government spending and the ₹35,400 crore maturity could ease the cash squeeze, though ICICI still expects the RBI to keep supporting banks.
Wednesday’s US Federal Reserve decision is the big event. A pause is widely expected, so the message matters more than the decision. The European Central Bank, the Bank of Japan, and US third-quarter GDP data are also due this week.
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