Why RBI’s liquidity play is reshaping bond market dynamics
Indian fixed income markets are being shaped less by macro anxiety and more by mechanics. Inflation has cooled, policy is supportive, and liquidity is being actively managed—yet bond yields remain firm. The reason is simple: supply has been heavy, and the market has demanded compensation to absorb it.
The Reserve Bank of India has made its priorities clear. With inflation comfortably below target and growth steady, the policy stance has turned accommodative but cautious. Rate cuts have been calibrated, and the emphasis has shifted decisively to transmission. Rather than signalling an aggressive easing cycle, the RBI has chosen to manage conditions on the ground.
Liquidity tools have taken centre stage. Over recent weeks, the RBI has stepped up variable rate repo (VRR) operations and open market purchases to anchor money market rates and ease funding conditions. The recent announcement of a fresh government bond OMO purchase alongside a USD-INR swap reinforced this approach. Markets responded immediately—government bond yields eased, sentiment improved, and concerns around near-term supply pressure moderated.
The message was unambiguous. The RBI is willing to step in when supply risks overwhelm fundamentals. By taking duration out of the market, OMOs help rebalance supply-demand dynamics, prevent unintended tightening, and reaffirm the central bank’s commitment to orderly market conditions. Expectations of further OMOs have strengthened, especially as government and state borrowing remain clustered.
That said, the firmness in longer-tenor yields should not be mistaken for stress. It reflects arithmetic, not anxiety. Heavy issuance—across central government bonds, state development loans, and PSU paper—has kept term premia elevated. This is a pricing adjustment, not a deterioration in credit or macro conditions.
Global signals add complexity but not discomfort. The US Federal Reserve has begun easing while remaining firmly data-dependent, keeping global bond markets sensitive to inflation surprises. Meanwhile, the Bank of Japan’s gradual policy normalisation has pushed Japanese yields higher, lifting global term premia and making duration positioning more selective worldwide. India, despite strong domestic fundamentals, is not insulated from these global forces.
Where returns are likely to come from
In this environment, fixed income investing is less about directional rate bets and more about return construction.
Duration continues to play a role. Absolute yields are attractive, and selective exposure offers income and diversification. However, supply and global factors suggest that gains may be uneven rather than linear.
The clearer opportunity lies in credit-focused strategies, deployed through a barbell framework.
At the front end, high-quality and liquid instruments benefit directly from RBI liquidity support, offering stable accrual and reinvestment flexibility. At the longer end, selective exposure to well-priced bonds allows investors to lock in carry as supply pressures are gradually absorbed.
Credit stands out as the most consistent return driver. High-yielding credits with improving balance sheets, predictable cash flows, and limited refinancing risk are offering compelling spreads. Defaults remain low, earnings visibility has improved, and valuations now reward discrimination. This is not about chasing yield, but about backing credits where fundamentals are quietly strengthening.
The bottom line
India’s bond market is not fighting the RBI—it is adjusting to supply. With inflation contained, liquidity actively supported through OMOs, VRRs and swaps, and the central bank signalling readiness to step in when needed, the backdrop favours steady income generation. In such a setting, a credit-led barbell strategy—anchored in quality and carry—offers a pragmatic path to compounding returns while the next phase of transmission plays out.
(Author Chirag Doshi is CIO of Fixed Income Assets at LGT Wealth India.)
Disclaimer: This story is for educational purposes only. The views and recommendations expressed are those of individual analysts or broking firms, not Mint. We advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and circumstances may vary.
