Indian government bonds experienced significant selling pressure on Monday, with the benchmark 10-year yield climbing as traders factored in unprecedented state borrowing plans amid weakening demand and tight liquidity conditions. The benchmark yield settled at 6.6331%, up from Friday's close of 6.6062%.

Record State Borrowing Pressures Market

States are preparing to raise a record ₹5 trillion ($55.40 billion) through bond sales between January and March, representing their largest quarterly borrowing on record. The immediate test comes with Tuesday's auction of ₹301 billion worth of state bonds.

The unprecedented borrowing program has created uncertainty about market absorption capacity, particularly as demand from key investor segments shows signs of weakening.

Foreign Banks Turn Net Sellers

Foreign banks turned net sellers last week, offloading ₹110 billion worth of bonds in their biggest weekly sale in nearly seven months, according to CCIL data. However, mutual funds continued to see value and purchased debt worth ₹93 billion in the first two sessions of January.

Traders noted that the supply surge has hit a market where investors are reluctant to build positions as expectations for further rate cuts have faded.

Liquidity Constraints Persist

Liquidity conditions remain constrained, with the banking system's average daily surplus declining to ₹614.4 billion as of January 2, down from ₹726 billion in December and ₹1.78 trillion in November. The Reserve Bank of India continued its open market operations, purchasing bonds worth ₹500 billion during Monday's session at higher-than-expected cut-off yields.

"The 6.70% level on the 10-year yield should see some resistance as RBI continues its open market purchases to ensure that short dollar positions do not evaporate liquidity," said Anil Kumar Bhansali, head of treasury at Finrex Treasury Advisors.

Interest Rate Movements Across Curve

India's overnight index swap rates rose across the curve on Monday as rising supply pressure weighed on bonds. The moves reflect broader bearish sentiment in the rates market.

The combination of record supply levels, reduced foreign participation, and tight liquidity conditions continues to create a challenging environment for Indian government securities, with market participants closely watching Tuesday's state bond auction for demand indicators.

The Rupee-Rouble trade mechanism continues to face significant obstacles as Indian financial institutions and service companies with US market exposure remain reluctant to participate due to potential sanctions risks, according to government sources. This cautious approach has prevented the materialization of the bilateral currency arrangement despite ongoing diplomatic efforts between India and Russia.

Trade Deficit Challenges and Strategic Objectives

India faces a substantial trade imbalance with Russia, with the world's largest country maintaining a $60.00 billion trade surplus. Government sources indicate that India aims to address this deficit by reducing non-tariff barriers for exports to Russia, creating more favorable conditions for Indian businesses to access Russian markets.

The current trade dynamics show Russia's economy focused on war-related activities, with most consumer product imports sourcing from China. However, marine exports from India have begun showing positive momentum, with Russia already relaxing import requirements for Indian marine products and considering further relaxations.

EAEU FTA Negotiations Progress

India's trade engagement with Russia is advancing through multilateral channels, with the second round of Free Trade Agreement negotiations with the Russia-led Eurasian Economic Union scheduled for February 2025. The Indian negotiating team will travel to Russia after the Union Budget 2026 presentation.

Key Discussion Areas and Regulatory Challenges

The upcoming FTA talks will address several critical areas including gateway issues, defense exports, and technology transfer arrangements. Government sources highlight significant scope for labor mobility across sectors, though language barriers may limit services sector movement to some extent.

Indian exporters currently face complex regulatory challenges due to overlapping requirements between Russian, EAEU, and European rules. The negotiations aim to provide clarity on export regulations, particularly for products requiring Russian language labels within and outside packages.

Marine Sector Developments

Russia's approach to Indian marine products demonstrates positive bilateral trade momentum. The relaxation of import requirements for Indian marine products represents tangible progress in reducing trade barriers, with additional relaxations under consideration.

The FTA negotiations represent India's strategic approach to addressing exporters' concerns while navigating complex international trade relationships. The focus on reducing non-tariff barriers aims to create more accessible pathways for Indian businesses to engage with the EAEU bloc, potentially reshaping the current trade deficit scenario with Russia.