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Informist, Tuesday, Aug. 25, 2026

 

By Aaryan Khanna and Cassandra Carvalho

 

NEW DELHI – Government bond traders are betting that the spread of the 10-year gilt yield over the five-year benchmark will narrow rapidly after the Reserve Bank of India's special window to mobilise foreign currency non-resident (banks) deposits closes Monday. In the last week of the scheme, the size of these bets are rising, especially as spreads widen again before the 10-year benchmark 6.94%, 2036 gilt's auction Friday, dealers said.

 

The "flattener" trade consists of short sales on the 6.36%, 2031 bond with an intention to pick up the 10-year benchmark 6.94%, 2036 gilt either in the secondary market or at the INR 340-billion auction, dealers said. The 10-year gilt yielded more than 39 basis points higher than the five-year bond at close of trade Tuesday from 35 bps Thursday. The 2036 gilt will likely underperform in the auction while incoming FCNR(B) flows are being deployed by domestic banks in the five-year gilt.

 

"After Aug. 31, the 5X10 spread (yield spread of 10-year benchmark over 5-year gilt) could come down to 30 bps over time," a trading head at a private-sector bank said. "Since this is auction week for the 10-year, it should bring some opportunities to enter for those who have the same view."

 

A proxy for tracking short sales in a particular bond is the number of trades in the paper in the special repo segment of the Clearcorp Repo Order Matching System. The data showed trades worth INR 80.38 billion in the 6.36%, 2031 gilt Tuesday, doubling since Aug. 17. The positive view on the five-year benchmark turned quickly after the RBI announced the special scheme would end a month earlier than scheduled, on Aug. 31. It was further jolted by the minutes of the August policy review, which showed the RBI's Monetary Policy Committee was considering rate hikes to curb rising inflation.

 

The gilt yield curve is expected to remain steep in August as banks are piling into short-term bonds while accumulating three- to five-year FCNR(B) deposits at a robust clip. Latest RBI data show these deposits swapped with the RBI rose by over $13 billion between Aug. 13 and Aug. 21 to a total of $65.40 billion. However, the change in the nature of these flows recently also makes the case for a flatter yield curve in September, dealers said.

 

Over the past two weeks, private-sector banks and state-owned lenders have drawn the bulk of the FCNR(B) mobilisation after raising dollars offshore and lending them to non-resident customers as leverage for deposits. At the same time, early frontrunners such as HSBC have taken a backseat after having achieved internal targets on deposit mobilisation, dealers said. Some foreign banks have found extending dollar loans to domestic institutions more lucrative than bringing in deposits themselves and then deploying them in bonds.

 

While asset-light foreign lenders were picking up bonds consistently, domestic banks were more interested in retiring high-cost liabilities and pushing loans, dealers said. The latter are only parking the incoming cash in the bond market temporarily and may sell gilts in September to generate cash to extend credit in the festival season, they said. Foreign banks have bought gilts worth INR 266.57 billion on a net basis in the secondary market in August, five times the purchases of public-sector banks, according to Clearing Corp. of India data as of Monday. Over five sessions till Monday, however, their average net buys have fallen to less than INR 1 billion, while state-owned banks have picked up gilts at a daily clip of over INR 26 billion. 

 

"Instead of taking a position in the 15-year paper, which has shown no signs of slackening demand despite the spreads being very tight, I would rather take a flattener on the five- versus 10-year paper," a dealer at a state-owned bank said. "The curve will flatten for sure and that's the place where there is the most conviction."

 

For most traders, this confidence on the yield curve flattening does not extend to gilts maturing above 10 years. The spread of the 15-year benchmark 7.06%, 2041 gilt over the 10-year benchmark has hovered around 20 bps through August. Long-term bond yields have also been kept in check as robust local demand has mitigated the impact of global bond yields rising to historic levels. This may not remain the case as supply pressures catch up to demand in the second half of the financial year, dealers said. 

 

Meanwhile, the 10-year benchmark gilt is expected to get more widespread support if its yield rises, with both 6.90% and 7.00% seen attracting persistent purchases from banks for their held-to-maturity portfolios. Consequently, some traders say this may lead to a "positive butterfly" effect on the government bond yield curve, where short- and long-term yields both rise more than the yields in the belly of the curve. 

 

"10X30 (yield spread of 30-year gilt over the 10-year benchmark) would steepen quite a bit and then 5X10 can flatten, so it's kind of a butterfly trade," a dealer at another private-sector bank said. "In OIS it's a simpler trade, it's simply a flattener... in G-sec (government bonds), the direction (of yields) is upwards only but because of the flows, that will get interrupted."  End

 

US$1 = INR 95.41

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

 

Edited by Rajeev Pai

 

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