India's bond market braces for liquidity challenges amid JP Morgan index inclusion

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India's bond market braces for liquidity challenges amid JP Morgan index inclusion
Credit: © Reuters.

India's anticipated inclusion in the JP Morgan Government Bond Index-Emerging Markets (GBI-EM) is expected to boost demand for sovereign debt, potentially leading to a liquidity management challenge for the Reserve Bank of India (RBI). This development, combined with factors such as the Fully Accessible Route (FAR) securities and projected foreign investments of $20-$25 billion, could result in a situation where demand outstrips supply.

In response to these potential challenges, experts including Gaura Sen Gupta from IDFC First Bank (NASDAQ: FRBA ) have suggested that the RBI might resort to open market sales of sovereign debt. Other tools that the RBI may utilize include variable rate reverse repo (VRRRs), cash reserve ratio (CRR) hikes, and aiming for a fiscal deficit target of 5.5% of GDP.

The situation is further complicated by higher headline retail inflation and potential rupee appreciation, both of which could add pressure on the RBI's liquidity management strategies. SBI (NS: SBI )'s Soumya Kanti Ghosh has predicted that these factors could push bond yields up to 7%.

As India prepares for its entry into the GBI-EM, the RBI's strategies and actions will be closely watched by market participants. The central bank's ability to effectively manage liquidity in the face of increased demand for sovereign debt will play a crucial role in maintaining financial stability in the country.

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