Indian Government Bonds Decline Amid Rising Oil Prices and RBI Swap Facility Closure

Indian government bonds stumbled in early trade on Tuesday, driven by rising crude oil prices and the Reserve Bank of India's (RBI) early withdrawal of a liquidity-boosting swap facility. The yield on the benchmark 6.94 per cent 2036 bond crept up 3 basis points to 6.8407 per cent by 10:45 a.m. IST, following a 5 basis point jump on Monday that marked its steepest one-day rise in over a month.

The downward pressure on bonds coincided with Brent crude topping $90 a barrel in Asian trade for the first time in nearly three weeks. The price surge followed the expiration of the 60-day U.S.-Iran ceasefire on Monday, with neither side indicating plans to renew it. As the world's third-largest oil importer, India remains acutely vulnerable to oil price fluctuations.

Sentiment was additionally weighed down by the central bank's policy shift. The RBI announced last week that it would close a zero-cost swap facility a month early, terminating a hedge offered to banks in June for foreign-currency deposits from non-resident Indians (NRIs). While inflows from the scheme exceeded $50 billion, policymakers opted for an early close due to concerns over domestic liquidity effects and the overall cost of fundraising.

Market participants noted that liquidity from these FCNR inflows had previously supported the five-to-six-year segment and the liquid 10-year bond. With that support fading, traders warn that the market is now more exposed to external swings in oil prices and global rates.

The five-year note has experienced the most severe impact on the curve. Its yield rose 8 basis points on Monday and climbed another 3.5 basis points on Tuesday to reach 6.4680 per cent. Overnight index swap rates also surged amid a strong paying bias, with the one-year swap up 5.5 bps at 5.8350 per cent, the two-year rate jumping 6.5 bps to 6.06 per cent, and the five-year rate climbing 9 bps to 6.4250 per cent.

As traders await a 202-billion-rupee state debt sale to test market appetite, the combined effect of the RBI's swap pullback and surging energy costs highlights the tightening liquidity conditions facing the domestic financial sector.

"The recent movement in Indian government bonds underscores how external macroeconomic factors like crude oil prices directly impact domestic financial markets. With the Reserve Bank of India closing its FCNR swap facility early, liquidity support is shifting, leaving shorter-term yields more sensitive to global rate changes. Businesses and financial stakeholders must closely monitor these liquidity transitions and currency movements as they navigate rising input costs and shifting debt market conditions." — Dr. Shishir Gupta, Founder & CEO, StartupLanes