Indian Bonds Rally: Liquidity Boosts Demand Amid Borrowing Fears

Indian government bond yields experienced a decrease throughout February, primarily supported by a surplus in banking liquidity which stimulated demand. This rally occurred ahead of the next fiscal year's record government borrowing.

The benchmark 6.48% 2035 bond yield concluded the month down by 4 basis points, reversing a three-month upward trend. Initial sentiment was affected by New Delhi's announcement of a gross borrowing target of 17.2 trillion rupees for the upcoming fiscal year, exceeding expectations.

Further influencing market sentiment was the Reserve Bank of India's policy outcome, which investors interpreted as less accommodative than hoped, particularly due to the absence of new liquidity-infusing measures.

Despite these pressures on the benchmark paper, a consistent liquidity surplus helped reduce yields across the shorter end of the yield curve. The two-year yield dropped 20 basis points, and the three-year yield fell by 16 basis points during February.

Demand for ultra-long 30- and 40-year bonds strengthened in the closing sessions, with their yields remaining largely unchanged for the month. This demand was partly fueled by market suggestions to maintain or reduce the proportion of longer-duration bonds in the upcoming fiscal year's supply.

India's overnight index swap rates also declined in February, marked by significant receiving activity, comfortable liquidity, and a fall in U.S. Treasury yields. The one-year and two-year OIS rates posted their largest monthly declines since April.