Bets against India's short-term bonds are surging as traders anticipate the Reserve Bank of India will drain excess banking system liquidity. Overnight short positions in the five-year benchmark bond pushed daily borrowing above 100 billion rupees ($1 billion) this month, roughly double early August levels, according to Clearing Corp. of India data. The security became the most shorted bond multiple times, a rare occurrence for the lowest-tenor security on the monthly liquid list.

Rajeev Pawar, head of treasury at Ujjivan Small Finance Bank, said the market is positioned for a large liquidity withdrawal by the RBI. Any durable cash drain could trigger a sharp rise in shorter-maturity yields. The build-up signals a broader shift as traders prepare for the 11 trillion rupee liquidity surplus to unwind. The RBI began withdrawing cash this week via foreign-exchange swaps, selling dollars to banks for rupees with agreements to repurchase later.

Despite high opportunity costs — traders earn as low as 2.5% on cash collateral versus 5.24% at the RBI — conviction remains strong. Banking liquidity will decline further with quarterly tax payments and record government borrowing. The five-year yield has risen 17 basis points in a month, near a three-month high. VRC Reddy, head of treasury at Karur Vysya Bank, said the bond is "extremely richly valued" after excess liquidity flowed into this segment.