Mumbai: India’s inflation is at an eight-year low, and the Reserve Bank of India (RBI) has been on a rate-cutting spree since February. However, counter-intuitively, India’s 10-year benchmark government bond yields surged, defying the normal pattern.
Bond yields have grown over 20 basis points since the RBI’s last rate cut in June. On Wednesday, the 10-year bond yield closed at 6.47 percent.
While bond yields tend to fall when interest rates are slashed, market experts say yields have been climbing due to mounting concerns over lower-than-expected tax collections, worries that the government may be unable to meet its fiscal deficit target, and the potential impact of the United States’ tariffs on Indian exports.
According to experts and traders, RBI’s change of stance from ‘accommodative’ to ‘neutral’, signalling a rate pause after three rounds of interest rate cuts, is also one of the factors that have pushed the bond yields up.
On 5 September, Union Finance Minister Nirmala Sitharaman, in an interview with Network18, also said that the rise in bond yields is “not affordable”. She, however, added that she won’t say she is concerned, and that it has no impact on her fiscal math as of now.
Independent analyst Ajay Bodke, who tracks economy & markets, told ThePrint, “The RBI stance clearly indicates that they are almost done as far as rate cuts are concerned. Although one can’t rule out further easing, it will come with a lag and the quantum might be smaller. Then there are concerns about fiscal slippage. If the economy slows down, there is a strong likelihood of a shortfall in direct & indirect tax collections.
He added that although the Gross Domestic Product (GDP) for the first quarter is encouraging, there are concerns over the continuance of economic buoyancy, given rising geopolitical risks, escalating trade & tariff wars, and lack of clarity about withdrawal of these punitive tariffs.
Typically, bond yields tend to be directly proportional to interest rates and inflation, and inversely proportional to bond prices. Usually, when interest rates and inflation are low, bond prices rise and yields decline.
For instance, if an investor purchases a Rs 1,000 bond that matures in 10 years with a five percent coupon rate, and the interest rates fall below five percent, the price of the bond will rise. This is because a bond with a coupon rate higher than the prevailing interest rate becomes more attractive if the investor wishes to sell the bond.
The current yield, meanwhile, is the bond’s return based on its current market price. It is calculated as a percentage by dividing the annual coupon payment of a bond by its current market price, making yields and prices inversely proportional.
But over the last three months, despite low interest rates and the July inflation rate being at just 1.55 percent, bond prices have fallen and yields have jumped, signalling investor unease.
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RBI’s change of stance
The RBI has slashed the repo rate consecutively over the last three Monetary Policy Committee meetings—first by 25 basis points in February, another 25 basis points in April, and another 50 basis points to 5.5 percent in June.
Bond prices and yields initially reacted predictably to the cuts, right up till June. Yields fell from 6.7 percent on 7 February, the day of RBI’s first rate cut of 25 basis points, to 6.18 percent on 5 June, a day before the June MPC decision.
Post the 6 June rate cut, however, yields started rising unexpectedly as the RBI also changed its stance from accommodative to neutral.
Author and columnist Tamal Bandyopadhyay told ThePrint, “The bond market sees the future. The perception is that now inflation has bottomed out, from here it can only go up. The market is also pricing in no further rate cut.”
A neutral stance indicates that RBI will neither opt for increasing money supply in the economy, nor reducing it—implying a rate pause.
“In June, when the RBI cut the rate by 50 basis points, it was a dovish approach, but the stance was moved from accommodative to neutral. Everything is based on perception. What the market read was that the RBI is done with rate cuts. This is the pivot, the end of it,” Ashutosh Khajuria, former executive director of Federal Bank, told ThePrint. “The continuous fall in yields stemmed, and all the negative news going on about Indian exports likely to be hit because of US President Donald Trump’s policies caused turbulence in the market.”
Khajuria, who is also an independent director on the board of Dhanlaxmi Bank, further said that when the market is in a neutral stance, the difference between the policy rate and the 10-year-benchmark yield usually hovers between 60-80 basis points.
So, given that the repo rate is at 5.5 percent, an additional 80 basis points will mean that the 10-year bond yields would be somewhere around 6.30 percent. However, bond yields breached even that threshold, and went up to 6.6 percent on 26 and 27 August, which, according to Khajuria, had more to do with global movements and other factors.
Fiscal deficit
Concerns over fiscal deficit can usually impact the bond market as it is funded by market borrowing.
Khajuria said, “If there is a perception that revenue is going to be lower than what was budgeted, then the fiscal deficit could be higher than what is expected. That means there will be more government borrowing, and if that happens, the prices of bonds will fall, and yields will go up.”
Last month, just as the Standard & Poor’s upgrade for India’s long-term sovereign credit rating to ‘BBB’ from ‘BBB–’ seemed to potentially give investors some confidence, Prime Minister Narendra Modi’s Independence Day announcement of cutting GST rates by Diwali sparked fresh concerns.
This is the government’s first rate rationalisation attempt under the GST regime. Following a two-day meeting, the GST Council last week announced a reduction to just two tax slabs of 5 percent and 18 percent—with effect from 22 September—from the existing four-tier structure of 5, 12, 18 and 28 percent. Besides, the government has proposed a 40 percent bracket for specific items, such as luxury vehicles, tobacco and cigarettes.
The 10-year government bond yields, however, softened just a bit after the new GST rates were announced as the investors had feared a steeper financial impact than the one projected. According to the Ministry of Finance, the net revenue loss due to GST rate cuts could be about Rs 48,000 crore on the consumption base of the 2023-24 fiscal year.
The GST Council announced the proposed new rates on 4 September. Bond yields closed 0.72 percent lower that day at 6.49 percent, slipping further to 6.46 percent on 5 September.
“The government has cut GST rates essentially because it wants anaemic aggregate demand to get a boost, especially in view of the massive drop in discretionary spends of lower-income households whose wage growth has not kept pace with inflationary pressures. Lowering of GST rates is expected to aid volume growth, boost demand, increase employment and lead to further business investments” Bodke said.
Neelkanth Mishra, chief economist at Axis Bank, said in a 13 August report that the primary drivers of the rise in the 10-year G-Sec (government securities) yields over the past two weeks are “weak direct tax receipts, worries over higher supply and investor positioning”.
According to him, direct taxes may miss the budget estimate for fiscal 2025-2026 by Rs 1.4 trillion. “The first quarter central fiscal data shows weak direct tax collection (down one percent year-on-year). The trend may not have improved in July-August. Direct taxes may miss FY26 budget est. (BE) by Rs 1.4 trillion,” Mishra said in the report.
He, however, added that a nine percent year-on-year nominal GDP growth, which would be one percentage point below the budgeted estimate of 10.1 percent, would allow a higher deficit at the target deficit ratio of 4.4 percent.
“Concerns about the government exceeding BE (budgeted estimates) are unfounded, as the headline figures for both revenue and capital expenditure overstate the actual spending,” the Axis Bank report further read.
During the April-July quarter, gross State Development Loan (SDL) issuances were 27 percent more, compared to a year ago. “This borrowing surge breaks from the usual pattern, where states typically backload SDL issuances in the second half of the fiscal year,” the report said. “Higher supply (partially unanticipated) without commensurate rise in structural demand (weak deposit growth means subdued demand from banks) has resulted in higher yields.”
Impact of US tariffs on Indian exports
According to Bodke, in view of punitive US tariffs and export slowdown, there is an attempt to assuage concerns by claiming that India can tap other markets and compensate for the potential revenue losses. However, such substitution is a “long-drawn, laborious process, and the margin profile in other markets is unlikely to match what exporters get from the US market”.
The impact, he said, is already being felt in centres with labour-intensive industries across the country, such as gems and jewellery, textiles, leather, dyes and chemicals, and so on.
Along with exports of goods, India’s services exports are also facing uncertainty with a proposed outsourcing tax under the new ‘Halting International Relocation of Employment (HIRE)’ bill, which has been introduced in the US Senate.
“The narrative is hardening out there (in the US). If the shrill voices in America start pressuring the administration and the corporate world in limiting outsourcing, the multiplier effect on our domestic demand too will be pretty high,” Bodke added.
SBI Research, in its Ecowrap report from 12 August, said that bond yields may not moderate till there is clarity regarding the economic impact of US tariffs.
“In the Indian markets, it is common to find debt market players behaving differently. For example, if one set of players acts procyclically with the RBI monetary policy stance, the other set of players acts counter-cyclically and sometimes both the players act combatively,” read the report. “However, after the announcement of the June policy, almost all market participants are selling/behaving in the same manner. This is surprising and resulting in a skewed price discovery despite headline inflation at an 8-year low.”
It added that the MPC’s decision could be split equally between indigenous and exogenous facts to figure out the actual impact of the tariffs. The impact may be felt with a lag as early numbers could be camouflaged by stockpiling and advance shipping. “The bond yield may not moderate until and unless a clarity would descend regarding tariffs,” the report said.
(Edited by Mannat Chugh)
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