India’s key money-market rates and yields on short-term debt rose after the central bank took its first small step toward unwinding emergency pandemic measures.

The interbank call rate rose to as much as 3.50% as against Friday’s weighted average of 3.18% while the yield on a five-year bond was up 10 basis points after the Reserve Bank of India said late Friday it plans to drain liquidity via a reverse repo operation.

The announcement is “a clear signal from the central bank that it wants to slowly start the process of exiting from the extraordinary accommodation that remains in place,” said Kaushik Das, chief economist for India at Deutsche Bank AG. “The central bank wants to nudge the various short-term interest rates to converge to the reverse repo rate gradually.”

There has been growing consensus among traders that the RBI will start draining excess cash, as surging liquidity caused money-market rates to drop below its interest-rate corridor last year, distorting asset pricing. Still, analysts had only expected it to act in the second quarter of 2021 after the central bank held its stance in December.

RBI’s announcement on Friday to retract 2 trillion rupees ($27.3 billion) of banking funds via a 14-day reverse repo operation on Jan. 15 was a surprise, said analysts including those at Citgroup Inc. The bank expects the yield curve to bear-flatten with forecasts for the 10-year yield to stay in the 5.75%-6% range.

The yield on the 5.15% 2025 bond jumped to 5.21%, while the benchmark 10-year yield was up four basis points to 5.92%. The one-month swap rate was eight basis points higher on Monday.

Data in Focus

The RBI’s decision to withdraw excess cash comes after inflation rose quicker than 6% in 11 of the 12 prior readings, hampering its ability to counter the pandemic-driven downturn with rate-cuts. However, data due Tuesday is forecast to show gains in the consumer price index slowing to 5% in December.

“It appears that the high frequency growth indicators are stabilizing,” Citi economists including Samiran Chakraborty wrote in a note. “These developments could have provided RBI with the comfort to start policy normalization.”

Staggered Approach

Cash in the banking system remains abundant at around 6.7 trillion rupees, according to the Bloomberg Economics India Banking Liquidity Index. Expectations are for a gradual reduction as the economy recovers from a pandemic-induced slump. The RBI would also avoid draining cash in a hurry amid a record government borrowing.

“While it’s too early to get out of the accommodative stance, a staggered approach to normalizing policy will be adopted,” Rini Sen, an economist at Australia and New Zealand Banking Group Ltd. wrote in a note. ANZ now expects no rate cuts in the fiscal year ended March 2022, compared to its earlier call for a 50 basis points reduction.