Indian government bonds ticked higher on Tuesday, as investors assessed the Reserve Bank of India's temporary liquidity draining operations, that allayed fears of more stringent operations.
The benchmark 6.94% 2036 bond yield ended at 6.9431%, versus 6.9607% on Monday.
India's banking system liquidity surplus hit a record 11.16 trillion rupees on Sunday, boosted by inflows from the RBI's dollar-attracting measures. It was last at 10.36 trillion rupees.
The RBI has been conducting variable rate reverse repo operations to absorb cash as excess liquidity in the banking system could loosen financial conditions beyond policymakers' intent, risking higher inflation and asset prices.
The central bank indicated last month that it could consider interest rate hikes if inflation risks persist.
Traders, said that they found some relief in the RBI sticking to VRRRs for absorbing liquidity rather than adpoting more stringent measures.
The higher than expected inflows from RBI's dollar deposit scheme have also alleviated India's balance of payment pressures.
"We now expect FY27 BoP to swing to a large surplus of $90 billion, or 2.2% of GDP, from our earlier estimate of $45 billion," BofA Securities said in a note.
The bank also said that liquidity tightening will help align the RBI's liquidity stance with its interest rate stance.
"Since the tightening is coming from a place of flush liquidity, the system as a whole is unlikely to feel a squeeze."
Concerns over higher interest rates globally on inflation and sovereign debt risks have however, dented demand for India's longer-dated bonds, limiting banks' scope to re-deploy cash into that part of the market.
Banks are currently favouring shorter-tenor instruments
such as VRRRs, T-Bills, CPs and CDs in the near term, traders said, with some deployment in 5-year government bonds.
RATES
India's overnight indexed swaps eased on Tuesday.
The one-year rate fell 2 bps to 5.95%, while the two-year rate was down 3.5 bps at 6.1350%. The five-year rate fell 3.5 bps to 6.43%.
