Debt Monthly View for February 2025

February 2025 kicked off with two key events in Indian bond markets: the Union Budget and RBI's Monetary Policy. The government remains committed to reducing the fiscal deficit, setting a target of 4.4% of GDP for FY26. In addition, the RBI Monetary Policy Committee (MPC) has reduced the repo rate by 25bps for the first time in almost five years, citing comfort in the inflation outlook and to add support for growth.

Both of these developments are favorable for domestic bond markets. However, towards the end of the month, uncertainty surrounding tariffs and the weakening rupee or rather dollar strengthening led to an increase in domestic bond yields.

In the money market, T-bill rates for the 3-month and longer segments plunged owing to the prevailing tight liquidity conditions. Meanwhile, the 3-month AAA PSU CP/CD rates moved up slightly to the 7.45%- 7.55% range on closing basis. The corporate bond yield curve continues to show strong demand in the 3–5-year segment. However, due to an increased supply in the 10-year segment, corporate bond yields in this maturity range have risen slightly.

On the global front, the US 10 -year Treasury yields fell from 4.55% to 4.20%, during the month on the back of weaker economic data boosting the rate cut expectations by the FED.

Banking system liquidity remained in deficit throughout the month, with the average daily deficit reaching Rs 1.68 trillion. Additionally, by February 21, 2025, core liquidity (adjusted for government cash balance and RBI cash reserves) turned into a slight surplus of approximately Rs 0.18 trillion. This was mainly supported by month-end Government spending, Open Market Operations (OMO purchases) of approximately Rs 0.8 trillion and a $ 10 billion FX swap.

Liquidity condition is expected to tighten further in coming months as cash withdrawals might continue during March 25 and April 25. RBI’s continued Forex(FX) selling would further tighten the liquidity condition. We expect durable liquidity to be in a slight deficit by the end of March 25, warranting the need for further liquidity infusions during March 25. Core liquidity may turn into a surplus after the RBI dividend in May 25.

January 25 Consumer Price Index (CPI) inflation came in at 4.3% y-o-y, driven mainly by a significant drop in food prices. Excluding vegetables, inflation was 3.8% (below the 4% target). Food inflation declined on a sequential basis, marking its first drop in 15 months, while core inflation remained below 4%.

In our estimates, February 25 inflation is trending toward the 4% range. With ongoing food disinflation and stable global oil prices, we expect headline inflation to align with the RBI's forecast of 4% for Q4 FY26. We anticipate another 25bp rate cut in April 25, reducing the repo rate to 6%.

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