Debt Monthly View for January 2025

Bond markets witnessed increased volatility during the last month with the 10-year Government bond yield jumping from 6.76% to 6.87% in first half of the month followed by a bigger drop in the second half to close at 6.69%.

Indian yields tracked the US 10 -year Treasury yields which moved from 4.58% to 4.79% and then fell to 4.51% during the same period.

Markets were driven primarily by stronger jobs data and the Fed’s hawkish pause on rate cuts. The Fed signaled no immediate reductions due to ongoing inflation concerns and the impact of President Trump's policies. This suggests a cautious approach as the Fed monitors inflation and waits for clarity on Trump’s trade and immigration policies.

In the money market, T-bill rates for the 6-month and longer segments plunged, closing the month at 6.62%, while rates for the 3-month segment remained steady at 6.55% owing to the prevailing tight liquidity conditions. Meanwhile, the 3-month AAA PSU CP/CD rates ended the month higher in the 7.45%-7.55% range against 7.30% in the previous month.

The Corporate bond yields remained broadly unchanged on monthly closing basis, maintaining a 40-50bps spread between G-sec and corporate bonds in the 10-year segment. The corporate yield curve continues to remain inverted.

Banking system liquidity remained in deficit throughout the month, with the daily deficit reaching Rs 3.15 trillion. Additionally, by January 24, 2025, core liquidity (adjusted for government cash balance and RBI cash reserves) turned into a deficit of approximately Rs 0.3 trillion. This was mainly supported by month-end Government spending, Open Market Operations (OMO purchases) of approximately Rs 200 billion and a Rs 450 billion FX swap.

The decline in core liquidity surplus was primarily due to the RBI’s sales of foreign exchange and seasonal pick up in cash withdrawals.

Liquidity condition is expected to tighten further in coming months as cash withdrawals tend to pick up during the January to March quarter. FPI selling could further tighten the liquidity condition. We expect durable liquidity to be in a slight deficit by the end of March, warranting the need for further liquidity infusions in late February or early March. Core liquidity may turn into a surplus after the RBI dividend in May.

Headline CPI inflation eased to 5.2% y-o-y in December 2024, while the ex-vegetable CPI (which accounts for 94% of the basket), stood at 3.68% y-o-y (remaining below the RBI’s 4% target for nearly a year). January data shows significant softening in vegetable prices. We expect the headline inflation to be ~4.5% in Jan, with core inflation (inflation excluding food and fuel) inching up slightly to 3.8% y-o-y due to higher gold prices. Easing inflation will open room for rate cuts going ahead.

Budget highlights:

The fact that the government maintained fiscal prudence is fundamentally positive for the bond market. The central government's debt to GDP is expected to steadily decline from 57.1% in FY 2024–2025 to less than 50% by FY 2030–2031 according to the medium-term fiscal forecast. This suggests that the fiscal deficit be reduced by at least 0.2% of GDP annually after FY26.

Gross borrowing in FY26 is higher at Rs 14.84 tn against Rs 14 tn in FY25, while net borrowing remains similar at Rs 11.54 tn. Despite the fiscal deficit being lower at 4.4% for FY26, market borrowings as a percentage of the deficit are up, and reliance on small savings has decreased. Borrowing from small savings is projected at Rs 3.43 tn in FY26, down from Rs 4.12 tn in FY25. Additionally, Rs 2.5 tn of switches are budgeted for FY26, effectively increasing the supply of long-term bonds in the year.

Monetary policy highlights:

The RBI MPC unanimously decided to cut repo rate by 25 bps and keep the monetary policy stance unchanged to ‘Neutral’. Effectively, the repo rate is at 6.25%, the Marginal Standing Facility (MSF) and Standard Deposit Facility (SDF) rates lowered to 6.50% and 6.00%, respectively.

The monetary policy met rate cut expectations, but the bond market was disappointed by its high expectations on liquidity and stance. We believe the RBI’s decision to maintain a ‘neutral’ stance is prudent, considering global uncertainties and currency volatility.

While no immediate liquidity measures were announced, the RBI reaffirmed its commitment to ensuring adequate system liquidity. An OMO purchase schedule is in place until Feb 20, with further purchases likely in March and April. However, with rising seasonal cash demand and a $24 billion FX forward maturity, durable liquidity could tighten in the coming months.

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