Market signals: A combination of factors has pushed up bond yields

Bond yields rise despite RBI rate cuts as fiscal risks, GST revenue loss, and global conditions fuel market anxiety, dimming hopes of easing borrowing costs

There is considerable anxiety in the financial markets over the rise in bond yields. As reported by this newspaper, commercial banks and other stakeholders have made several suggestions to the Reserve Bank of India (RBI), aiming to ease pressure on the bond market. It has been suggested that the RBI extend the bond issuance till March rather than concluding the annual sale in February. This will help reduce the weekly supply of bonds. Stakeholders have also suggested changes in the way state-government bonds are sold to reduce the spread. It has also been said that issuing ultra-long duration bonds like those with tenors of 30-50 years should be reduced. Banks have also underscored that the weekly issuance of bonds has increased significantly. 

While the measures suggested by stakeholders may ease some pressure, it is worth debating why yields have risen and how they are likely to move in the coming quarters. The yield on 10-year government bonds has increased by about 20 basis points since the Monetary Policy Committee of the RBI decided to frontload the rate cut and reduced the policy repo rate by 50 basis points in June. Theoretically, after a bigger than expected rate cut by the central bank, bond yields should ease. However, in this case, market participants decided not to go by the book. One plausible reason could be that the market interpreted the June policy statement, and the subsequent August statement, along with the inflation projections, as the end of the rate-cutting cycle. The August policy statement, the latest, projected the inflation rate at 4.4 per cent in the fourth quarter this financial year. It is further expected to increase to 4.9 per cent in the first quarter of 2026-27. Since the monetary policy needs to be forward-looking, as things stand, there is virtually no space for further rate reduction. 

The financial markets may also be pricing in possible fiscal pressure. The Goods and Services Tax (GST) Council last week decided to rationalise the rate structure. According to the government, this could have a revenue implication worth ₹48,000 crore. In the coming quarters, a lot will depend on how demand in the economy responds. However, from a longer-term perspective, the council has further reduced the average GST rate, which could have implications for longer-term fiscal sustainability. The average rate before the rationalisation exercise was about 11.6 per cent, compared to a 15-15.5 per cent revenue-neutral rate recommended by a government committee. Structurally lower GST rates and collection could impair the ability of both the central and state governments to reduce their fiscal deficit and borrowing on a sustainable basis. Further, the Union government, starting next financial year, will move to a new fiscal framework where it will aim to keep the central-government debt on a declining path as a percentage of gross domestic product. While this will give the Union government greater flexibility in managing the Budget than in committing itself to a fixed annual target, it could also create uncertainty in the bond markets. 

Further, the global conditions are not favourable. Higher yields in advanced economies will affect demand for Indian-government bonds. Foreign portfolio investors, for instance, have purchased Indian bonds worth $542 million so far this financial year, as against over $14.5 billion in 2023-24. Therefore, given the monetary, fiscal, and external environment, the chances of a meaningful softening of bond yields remain low. A lot will depend in the near term on market expectations of inflation.