India 10-year G-Sec yield rises on RBI liquidity drain

The key catalyst was not just this week’s monetary policy decision, but the market’s read-through from it. Investors had largely expected a 25 basis-point rate increase, yet the RBI’s warning on persistent inflation and its guidance that policy may need to stay tight for longer forced a repricing of the entire curve. In bond markets, expectations often matter as much as the actual rate decision, and Friday’s sell-off showed traders adjusting to a central bank that appears less inclined to ease financial conditions than previously assumed.

Open market operation sales are now central to that reassessment. The RBI has already announced an OMO sale of ₹25,000 crore on Oct. 13, and treasury officials expect further sales that could total roughly ₹1 lakh crore in coming weeks. Because OMOs remove cash from the system by selling government securities, they can tighten liquidity without changing the policy rate — and that combination typically puts direct upward pressure on yields.

That is why market participants are increasingly focused on the balance between inflation control and funding stress. Rajeev Pawar, head of treasury at Ujjivan Small Finance Bank, said traders had been comfortable with surplus liquidity of around ₹3-4 lakh crore in the system, but now believe the RBI wants to withdraw more than previously anticipated. He said a gradual move toward 7.5% on the benchmark yield before the next policy meeting was possible.

The inflation backdrop is reinforcing that view. Traders are bracing for a hotter retail inflation reading next week, and the central bank’s latest communication has made it harder to argue for near-term rate cuts. V Rama Chandra Reddy, head of treasury at Karur Vysya Bank, said expectations of elevated inflation alongside additional OMO sales were driving the persistent hardening in yields.

For investors, the shift has several implications. Government bond holders face mark-to-market losses if yields continue to rise, especially on longer-duration paper. Banks and insurers, which are major holders of sovereign debt, may also see portfolio volatility increase. At the same time, higher government yields can crowd out private borrowing, making it more expensive for companies to issue debt and for households to access credit.

The market is now talking about a higher terminal rate than it did only days ago. Reddy said consensus had previously placed the repo rate peaking between 5.75% and 6%, but the market is now pricing a terminal rate as high as 6.25% by fiscal 2027, implying as much as 100 basis points of cumulative tightening from current levels. That would keep pressure on bonds and challenge any quick recovery in risk appetite.

The bull case is that if inflation moderates and liquidity tightens only gradually, the sell-off could prove overdone and yields may stabilize near current levels. The bear case is that the RBI follows through with larger or more frequent OMO sales, inflation stays sticky and the 10-year yield pushes toward 7.5%, forcing another round of portfolio de-risking.