RBI’s Liquidity Pledge Spurs Demand for Shorter India Bonds

(Bloomberg) -- Bullish bets on India’s short-term bonds are making a comeback after the central bank pledged to maintain abundant liquidity in the banking system to support the economy.

The Reserve Bank of India surprised bond traders on Friday when it didn’t take steps to pare back on the cash glut that caused short-term rates to collapse. Instead, it reiterated liquidity support for the debt market with instruments including open-market bond purchases.

“Before the policy, we had taken some profit in the absolute short-end of the curve” with duration up to three months, said Lakshmi Iyer, chief investment officer for fixed income at Kotak Mahindra Asset Management Co. “We have added back those positions because there is no merit in staying in hard cash when there is not going to be an immediate liquidity stance change,” she said.

Traders were jittery going into RBI’s policy review as a range of overnight rates had dropped below the lower bound of the central bank’s rate corridor. Seven months of high inflation had also reinforced expectations that the policymaker would need to roll-back some of the excess liquidity.

The RBI on Friday dismissed both of those concerns. It called the plunge in money markets the result of an “asymmetrical distribution of liquidity,” which mattered less than its efforts to support growth. The central bank also said it’ll keep a close eye on inflation, which it sees as been largely driven by supply-side disruptions.

Moreover, Prime Minister Narendra Modi’s government is considering recommending a looser inflation target for the central bank from the current 2%-6% range, allowing it to focus more on economic growth despite price pressures, according to people familiar with the matter.

“With the market’s mind relieved for now on the overnight anchor, interest with respect to front-end rates should get re-established,” said Suyash Choudhary, head of fixed income at IDFC Asset Management Ltd. in Mumbai. With some gentle reversals expected in overnight rates over the next year, “we have reverted to an overweight position in our long preferred six–nine-year segment in government bonds.”

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