Indian Government Securities Yield Curve Expected to Steepen Further Amid FCNR-B Inflows

The G-sec yield curve is likely to steepen further as foreign currency non-resident ( FCNR -B) deposit inflows boost demand for shorter-dated government securities. The inflows are adding to rupee liquidity and supporting demand at the short end of the curve. Driven by FCNR-B inflows, the five-year G-sec yield has fallen 44 basis points since the June policy, compared with a smaller decline in the 10-year benchmark yield. The spread between the five-year and 10-year bonds has widened to 41 basis points from over 15 bps in May. On Wednesday, the five-year and 10-year yields closed at 6.35% and 6.76%, respectively. The benchmark 10-year paper has largely traded in the 6.73-6.84% range over the past month. The Reserve Bank of India’s latest policy was seen as dovish, with the central bank cutting its inflation projections. This has prompted banks to scale back expectations of future rate hikes, while longer-tenure government securities are expected to remain range-bound in the near term. “When liquidity is abundant and an immediate rate hike is off the table, short-term rates tend to fall immediately. This typically leads to a steeper yield curve, as the absence of near-term tightening expectations, combined with excess liquidity, gets priced into the front end of the curve,” said Gopal Tripathi, treasury head at Jana Small Finance Bank. As long as foreign exchange inflows continue, overnight liquidity is likely to remain elevated, keeping the short end of the yield curve benign and supporting further steepening, he added. According to Reserve Bank of India data, Indian banks have mobilised $36.73 billion through the special FCNR-B deposit scheme. A total of $40.82 billion in foreign exchange had been received through the RBI’s measures as of July 31. The measures are expected to attract around $70-80 billion of inflows, helping bridge the balance of payments gap and support the rupee. Following the inflows, banking system liquidity rose to an average surplus of Rs 3.43 lakh crore over the past week, compared with Rs 1.52 lakh crore in the previous week. “Most of the FCNR-B inflows are deployed immediately into G-secs. We can also see inflows coming into the OIS market. As a result, the market broadly expects further steepening of the yield curve, with any positive geopolitical developments likely to support the entire curve,” said a dealer at a primary dealership. The benchmark 10-year paper is expected to trade in the 6.75-6.85% range in the near term, the dealer added.