By Dharamraj Dhutia
MUMBAI (Reuters) - Tight liquidity conditions and sticky inflation will keep the four-year to 10-year part of the Indian government bond yield curve inverted, traders said on Monday.
"The curve has inverted because of tight liquidity expectations for September, and materially we do not see anything changing until the end of this month," said Vijay Sharma, senior executive vice president at PNB Gilts.
The four-year 7.38% 2027 bond yield was 7.25%, while five-year 7.06% 2028 bond yield stood at 7.24%. Benchmark 7.18% 2033 bond yield was 7.20%, an inversion of around 4-5 basis points.
Investors have been shying away from near-maturity papers after inflation scare and the Reserve Bank of India's aggressive liquidity withdrawal.
Even though the RBI announced a phased withdrawal of incremental cash reserve ratio (I-CRR), the market expects liquidity to drop into deep deficit for the next couple of weeks amid tax outflows, impacting short-end appetite.
The headline liquidity that excludes the government's surplus cash balances would be in deficit of around 500 billion rupees to one trillion rupees ($6-$12 billion) due to tax outflows this fortnight, said Vivek Kumar, an economist at QuantEco Research.
Retail inflation in July spiked to a 15-month high of 7.44%, while the August reading will likely be around 7.00%, sharply above the central bank's tolerance band, raising fears of higher-for-longer interest rates.
Traders expect the inversion to reverse if government supply tightens in the shorter end for October-March.
"If in the second half borrowing, there is less supply in the five-year tenure, and with bond maturities, there can be some steepening," said Abhishek Bisen, head of fixed income at Kotak Mahindra Asset Management.
Indian bond market participants urged the government to increase the supply of 30-year and 40-year bonds and cut down shorter tenor papers in October-March.
($1 = 82.8142 Indian rupees)