WHY AXIS MF BELIEVES RBI’S SURPLUS LIQUIDITY COULD STEEPEN THE YIELD CURVE

The Reserve Bank of India’s liquidity injections and a likely record dividend in FY26 could create a steep yield curve, according to a new report from Axis Mutual Fund.

This will boost the appeal of short-term corporate bonds, the report said.

The RBI has pumped over ₹10 lakh crore into the banking system since December 2024, swinging liquidity from a ₹3 lakh crore deficit to a surplus of ₹1.25 lakh crore by March 2025.

This surplus is now expected to rise further with an anticipated dividend of over ₹2.5 lakh crore, pushing total durable liquidity above ₹6 lakh crore in the near term.

“Maintaining liquidity above 1% of NDTL (Net Demand and Time Liabilities), coupled with weak credit demand, is expected to drive a rally in the shorter end of the fixed income curve,” Axis MF said in a note dated May 20, 2025.

The shift marks a departure from previous RBI behavior.

Over the past 15 years, sustained liquidity above 1% of NDTL (Net Demand and Time Liabilities) was only seen during demonetisation and the Covid-19 crisis.

The fund house now sees this becoming the new normal—potentially steepening the yield curve, as happened in those earlier periods.

The report notes that although the RBI has only formally cut rates by 50 basis points, the effective easing is closer to 100 bps. The overnight rate has dropped from the Marginal Standing Facility rate of 6.75% to the Standing Deposit Facility rate of 5.75%, thanks to the liquidity glut.

This easing is aimed at supporting a slowing economy.

Axis MF estimates India’s GDP will grow at 6.3% in FY25, down from the previous year’s 7%, citing tight financial conditions, weak external growth, and a decline in government spending.

“We do not foresee the need for further RBI intervention at this time,” the fund house stated, adding that any additional open market operations (OMOs) will likely be limited to ₹1–1.5 lakh crore unless foreign exchange outflows intensify.

The report said that 1–5 year corporate bonds are now better positioned than longer-duration bonds, given the risk-reward profile in a shallow rate-cut environment. Meanwhile, long-term government bonds may see limited gains, as the central bank slows down its OMO activity.

2025-05-23T04:05:03Z