The Reserve Bank of India has injected ₹2.5 lakh crore into the banking system over a week to counter a sharp liquidity drain. A ₹1.5 lakh crore four-day variable rate repo auction on October 26 followed a ₹1 lakh crore seven-day operation. The banking system's surplus liquidity had fallen to ₹50,000 crore, or 0.2% of net demand and time liabilities, by October 23 due to GST payments and higher cash reserve requirements. This squeeze pushed the overnight call money rate to 5.74%, above the RBI's 5.50% repo rate and near the top of its policy corridor.
These domestic injections are being offset by external pressure from oil prices. Brent crude is trading near $116 a barrel, a six-month high, on supply disruption fears. For India, which imports 85% of its crude, the cost has surged. The crude oil import bill rose 48% to $91.52 billion in the first half of this financial year compared to the same period last year, despite broadly unchanged import volumes.
Bond yields caught in the crossfire
The result is a tug-of-war in the bond market. The RBI's liquidity support aims to lower short-term borrowing costs and provide stability. However, high oil prices widen the trade deficit, increase dollar demand, and pressure the rupee. A weaker rupee imports inflation and raises the risk of the RBI hiking interest rates to defend the currency. On October 26, bonds gave up early gains as oil prices held near $115, with the 10-year yield ending 1 basis point higher at 7.4826%.
This dynamic has lifted market expectations for tighter monetary policy. The one-year overnight indexed swap rate is pricing in roughly 100 basis points of rate increases over the next twelve months. The RBI has already raised its inflation forecast. Consequently, the 10-year benchmark bond yield is expected to trade in a 7.40% to 7.60% range, caught between domestic liquidity support and imported inflation risks.
For fixed-income investors and traders, the market is pricing a conflict. The RBI's operations signal a desire to manage domestic liquidity conditions smoothly ahead of tax outflows. Yet the scale of the oil shock forces a parallel assessment of currency defence and inflation control. Bond gains will remain capped until oil prices retreat or the RBI's stance on rates becomes clearer than the current swap market pricing.