Rupee to fall more, yield curve to shift higher in H2FY27: Gaura Sengupta

The rupee is expected to depreciate further against the US dollar, with RBI becoming increasingly selective in its intervention strategy, said Gaura Sengupta, chief economist, IDFC First Bank

Disclaimer: This article is written by Gaura Sengupta, chief economist at IDFC First Bank. Views expressed are her own. Readers' discretion is advised. 

Rupee, G-sec outlook for H2FY27

 India's financial markets, both bonds and forex, have remained remarkably stable despite the upheaval seen globally. To put things in context, the yield on the US Treasury 30-year Note has touched levels last seen 20 years ago. The West Asia crisis has persisted for more than six months, resulting in global crude oil inventories falling to historical lows. Global trade continues to face repeated and unprecedented supply-side shocks in an increasingly protectionist environment, with tariffs becoming the new weapon of choice. 

 

Against this tumultuous backdrop, India's growth momentum has surprised on the upside and markets have remained relatively stable. The recently concluded FCNR(B) scheme has reinforced the Reserve Bank of India’s (RBI's) forex reserve buffers, providing much-needed breathing space for monetary policy. The rupee has seen a much more moderate pace of depreciation in the financial year (FY27), weakening by just 1.2 per cent compared with 11 per cent depreciation in FY26, despite a far more adverse global environment. The AI-led capex supercycle in the US has boosted growth and, in turn, supported the US dollar. The oil shock has also strengthened the greenback through safe-haven demand, while the US also benefits as a net exporter of crude oil. 

RBI intervention has been the key factor behind the rupee's stability in FY27. Following the FCNR(B) inflows, the pace of intervention increased, helping limit depreciation pressures. Going forward, however, we expect RBI intervention to become more cautious as the FCNR(B) window has now closed. The $133 billion mobilised through the scheme is borrowed money that will need to be repaid beginning three years from now. Other capital inflows remain weak, with continued foreign portfolio investors (FPI) outflows and subdued debt inflows. While the Balance of Payments shifted into a substantial surplus in the second quarter (Q2FY27) due to FCNR(B), it is expected to turn negative again in H2FY27. Moreover, the current environment of US dollar strength and elevated US Treasury yields could persist, making it challenging for emerging markets to attract foreign capital. 

The upward pressure on US Treasury yields is being driven by elevated US government debt and deficits, which are likely to persist as US fiscal policy remains expansionary. At the same time, the AI-led capex cycle is being driven by large corporations with relatively low leverage and could continue if the Fed rate hiking cycle remains shallow. If these conditions persist, RBI may need to focus on conserving forex reserves as Balance of Payments (BoP) dynamics weaken. Consequently, the rupee is expected to depreciate further against the US dollar, with RBI becoming increasingly selective in its intervention strategy.

 Bond markets The bond market has also come under pressure, with G-sec yields gradually rising as domestic inflation concerns increase and markets price in RBI rate hikes beginning in October. The European Central Bank (ECB) and US Federal Reserve have already embarked on rate hiking cycles in response to rising inflation pressures. The increase in G-sec yields reflects a combination of monetary policy expectations and supply pressures. In H2FY27, net G-sec and state government bond supply is expected to rise sharply to ₹12.7 trillion from ₹9 trillion in H1FY27. This reflects both a change in the Centre's issuance pattern and higher state government borrowing. 

Unlike previous years, when Centre borrowing was more concentrated in H1 to avoid competing with states, FY27 borrowing has been distributed more evenly across the year due to the West Asia crisis. As a result, the Centre and states will compete for funds in H2FY27 against a backdrop of RBI rate hikes and elevated global yields. Adding to the pressure, RBI is withdrawing excess liquidity created by FCNR(B) inflows through OMO sales and sell-buy swaps. The OMO sales increase supply at the short end of the curve. 

The Centre has reduced issuance in maturities of up to seven years to create space for RBI's OMO sales, shifting supply to the 15-year and ultra-long segments in the H2FY27 g-sec borrowing calendar. Consequently, both ends of the yield curve are expected to face upward pressure: the short end from OMO sales and rate hikes, and the long end from increased supply. State government borrowing, which dominates in H2 and is typically duration-heavy, will further add to long-end pressures. As a result, the entire G-sec curve is expected to shift higher, reflecting a confluence of domestic and external headwinds.