PM Modi's cash build-up adds to litany of India's bond market woes

First it was the rising oil price that spooked investors in India’s bond market. Then demand for sovereign debt from state-owned banks dried. Now another pillar of support -- liquidity -- is giving way.

A seasonal crunch in the banking system is becoming acute because of a buildup in the cash the government parks at the central bank. A lumpiness in revenue -- a bulk of it flows into state coffers toward March -- and a drop in spending has swollen these balances to between 500 billion rupees ($7.7 billion) to 1 trillion rupees, according to Edelweiss Securities Ltd.

The surplus banks had enjoyed since Prime Minister Narendra Modi’s surprise ban on high-denomination notes in 2016 is also a thing of the past. Excess deposits that lenders left with the central bank have turned into a deficit of 337 billion rupees as of Feb. 27, after touching a record 5.5 trillion rupees in March 2017, Bloomberg Economics India Banking Liquidity Index shows.

“Liquidity has already reached a stage where the rise in government balances is leading to a deficit in the banking system liquidity,” said Vivek Rajpal, a rates strategist at Nomura Holdings Inc. in Singapore. While redemption of market stabilization bonds will add liquidity in mid-March, advance corporate tax outflows will be large enough to widen the deficit, he said.

That’s not good news for a market that’s seen 10-year bonds drop for seven months through February, the longest-losing run according to data compiled by Bloomberg starting in November 1998.