Bond Yields Diverge Despite RBI Rate Cuts: Liquidity Crunch
Why in the news
Despite an RBI repo cut of 25 bps, borrowing costs for companies and banks went up even as the benchmark 10-year G-sec yield touched a three-year low. A liquidity shortage blocked transmission of the cut.
Key facts
- Repo-to-corporate bond spread: 125 bps; G-sec to corporate/state bond spread: from 30-35 bps to 45-55 bps.
- Tight liquidity typically accompanies tight policy against inflation; excess liquidity followed the 2008 crisis and COVID-19.
| RBI tool | Action |
|---|---|
| Buy-sell swaps | Three-year $10 billion auction on 24 March (about ₹86,000 crore); earlier swaps on 28 February and 19 January (six-month, $5 billion) |
| VRR auctions | Daily, giving banks funds at market-set rates |
| OMOs | ₹1 trillion in March, in two tranches (12 and 18 March) |
| CRR | Cut 50 bps to 4% in December, freeing ₹1.12 trillion; legal floor is 3% |
Foreign flows and rupee
- FIIs and FPIs are the healthiest liquidity source: ₹34,574 crore left in February 2025; ₹1.12 trillion in the first two months; ₹2.12 trillion since October 2024.
- Rupee fell over 4% (₹83.81 to ₹87.50) between October 2024 and February 2025; US bonds paying 4.5% risk-free deterred inflows.
- It later recovered to ₹85.98; the dollar index eased from 110 to 104.
Liquidity and outlook
- OMOs expand RBI’s rupee balance sheet; swaps add to foreign currency reserves.
- In January, $82.6 billion of $640 billion reserves were short-term buy-sell swaps, deferring ₹7.5 trillion of liquidity withdrawal.
- A mix of OMOs and long-term swaps is best; without ample liquidity, April cuts will not reach borrowers. FPI return is the key turning point.
Exam angle
- CRR floor by law: 3%.
- CRR after December cut: 4%.
- Instruments: VRR, OMO, buy-sell swap.