Indian government bonds surge as RBI steps in to ease liquidity strain

Indian government bonds recorded their strongest rally in four months on Wednesday, after the Reserve Bank of India rolled out fresh liquidity measures aimed at stabilising money markets and containing a recent rise in borrowing costs.

The move came at a time when banking-system liquidity has tightened sharply, bond yields have climbed to multi-month highs, and pressure on the rupee has intensified.

By announcing a mix of government bond purchases and a foreign-exchange swap, the central bank signalled its intent to smooth market conditions and counter recent cash drains, triggering a broad-based bond rally.

The RBI said on Tuesday evening that it will purchase 2 trillion rupees of government bonds in four tranches spread across December and January.

It also announced a $10 billion foreign-exchange swap to be conducted next month.

Following the announcement, the benchmark 10-year government bond yield fell to 6.54%, marking its sharpest single-day decline since Aug. 14.

Liquidity boost drives bond rally

The bond purchases represent a significant escalation in the RBI’s liquidity support.

The planned infusion is double the amount announced earlier this month, underlining the central bank’s concern about tightening financial conditions.

Markets had been under pressure after the benchmark yield touched a nine-month high earlier this week, reflecting worries about liquidity stress.

According to Bloomberg, experts said the measures changed near-term yield dynamics, with several now seeing room for the 10-year yield to ease toward the 6.50% level.

The rally was broad, reflecting improved sentiment across maturities as expectations of sustained liquidity support took hold.

Offset for rupee-related cash drain

A key objective of the latest steps is to counter the impact of the RBI’s interventions in the foreign-exchange market.

The central bank has been selling dollars to support the rupee, which has emerged as Asia’s worst-performing currency this year.

Those dollar sales have drained rupee liquidity from the banking system, adding pressure to short-term funding markets.

The foreign-exchange swap, alongside bond purchases, is expected to help replenish liquidity while allowing the RBI to continue managing currency volatility.

The measures also come as lenders face seasonal pressures from tax-related outflows, which have further tightened cash conditions.

Bloomberg data shows that banking-system liquidity slipped into a deficit of 727 billion rupees on Dec. 22.

This marks a sharp reversal from a surplus of 2.6 trillion rupees seen earlier in the month.

The shift has pushed up overnight borrowing costs for banks, amplifying stress across money markets.

The RBI’s actions appear designed to prevent these pressures from spilling over into broader financial conditions, particularly at a time when global factors, including punitive US tariffs, are weighing on growth-sensitive assets.

Market positioning adds support

The bond rally was also supported by recent positioning data.

Figures released after trading ended on Tuesday showed that a category of market participants, including the RBI, purchased 47.4 billion rupees of government notes.

This was the highest such buying since Nov. 11 and provided additional reassurance of official support for the market.