The Reserve Bank of India (RBI) is expected to raise the repo rate by 25 basis points in October, with further hikes likely in FY27 as inflation risks persist, potentially pushing the benchmark rate to 5.75-6 per cent, pressuring G-sec yields, as per a report by Union Bank of India.
The lender noted in its report that Indian government bonds remained under pressure in September as high crude oil prices and rising global yields strengthened expectations of RBI rate hikes. At the same time, higher domestic bond supply, including RBI open market operation (OMO) sales and increased long-tenor issuance in the second-half borrowing calendar, added to the pressure and kept yields elevated despite lower overall government borrowing.
"The pressure was particularly visible in the 5-year segment. Over September, the 5-year G-Sec yield rose 45bps, compared with 24bps for the 10-year, narrowing the 10-year minus 5-year spread from 36 to 16 bps," it noted.
It further noted that the government plans gross dated G-Sec borrowing of Rs 7.86 lakh crore in H2FY27, with the gap between budgeted and projected gross borrowing at around Rs 1.1 lakh crore.
However, net borrowing remains broadly unchanged "as redemptions have been reduced by aggressive switch auctions, as bond switches have deferred repayments, reducing redemption requirements and refinancing needs in FY27."
Higher T-bill issuance and moderately higher state borrowing are also expected to add to market supply.
The report further highlighted that the central bank continues to absorb the FCNR(B)-led surplus through variable rate reverse repo (VRRR) auctions, open market operation (OMO) sales and foreign exchange swaps. OMO sales totalled Rs 1 lakh crore across three September auctions, helping reduce the banking system liquidity surplus to Rs 4.85 lakh crore as of September 30 from Rs 11.16 lakh crore on September 6.
As per the lender, "A broad CRR hike appears less preferred, given RBI's earlier exemption of eligible FCNR(B) deposits from reserve requirements."
According to the report, a broad-based cash reserve ratio (CRR) hike appears unlikely, given the RBI's earlier decision to exempt eligible FCNR(B) deposits from reserve requirements.
"We expect a 25bps rate hike, followed by one or two additional hikes during the remainder of FY27, taking the repo rate to 5.75-6.00%, accompanied by hawkish guidance signalling continued vigilance on inflation," it said, stressing "10-year G-Sec yield could face further upward pressure if policy tightening coincides with persistently elevated crude prices, rising global yields and subdued auction demand."
