Over the past two years, Indian bonds have demonstrated remarkable resilience amid global economic volatility. This strength was largely underpinned by the Reserve Bank of India’s (RBI) monetary approach and fiscal discipline by the central government.
Since February 2025, the central bank has eased the liquidity situation. It implemented a cumulative rate cut of 100 basis points (1%), while injecting nearly ₹5.5 trillion in liquidity through various tools. As a result, yields on Indian bonds have fallen. This decline has resulted in spread between India’s and the U.S.’s 10-year government bond shrinking from 4.5% in 2022 to a low of 2% by July 2025.
Additionally, the overnight operating rate i.e. the rate at which money is lent or borrowed overnight, declined by 125 bps sinceFebruary 2025.This decline in cost of money has led to reductions in both term deposit rates and the weighted average lending rates of scheduled commercial banks.
Aggressive easing leaves limited policy room
In a significant policy move, the RBI frontloaded its rate easing with a 50 bps cut in June 2025, followed by a planned phased reduction of the Cash Reserve Ratio (CRR) by 100 bps, starting from September 6. As a result, the 10-year Indian Government Bond (IGB) yield fell to 6.13%—its lowest since mid-2021. However, with much of the monetary easing already delivered, the RBI may have little room left for further intervention.
Tariff wars and fiscal concerns cloud outlook
Buoyed by strong Q1 FY2025-26 GDP growth of 7.8%, domestic economic activity appeared resilient. Despite robust domestic fundamentals, global developments are now catching up with Indian bonds. The U.S. administration’s new trade tariffs, including an additional 25% penalty on select products, have pushed effective average tariffs to nearly 20%. With no clear progress on trade negotiations, tensions across the world are mounting.
India’s cautious stance on geopolitical issues and resistance to opening its market to certain dairy and agricultural imports—citing farmer protection—has further complicated trade talks. Analysts estimate that the ongoing tariff war could shave off 50–75 bps from India’s growth outlook.
Currency devaluation
The Indian Rupee also weakened vis-à-vis to the US Dollar to a record low last week, touching the 88/USD mark amid growing concerns. While the depreciation may enhance export competitiveness, its impact is minimal compared to the effects of tariffs.
In response, the government is considering fiscal measures. Cuts in Goods and Services Tax (GST) rates have already been announced. However, such a move could lead to a fiscal slippage of approximately 500 billion, raising alarms in the bond market.
Rising yields, widening spreads
Major developed economies are showing signs of fiscal recklessness, increasingly pressuring the long end of their yield curves, with yields now trading at decadal highs.
The U.S. 30-year bond is near 5%, Japan’s 30-year yield has risen to around 3.25%, and the U.K.’s 30-year gilt at 5.50%—levels that are raising concerns among global investors.
Amid these global uncertainties, domestic investors are demanding higher term premia across both central and state government bonds.
Over the past month, the Indian Government Bond (IGB) yield curve has shifted upward by 30 basis points for 10-year and 35 basis points for 40-year G-Secs. Meanwhile, state government borrowings have surged 35% year-to-date, adding to the supply glut. As a result, spreads between state development loans (SDLs) and corresponding G-Sec maturities have widened—from 40 basis points in FY2025 to 75 basis points in FY2026. What this means is that the incremental demand for borrowing from state governments remains elevated, as a result the cost of borrowing is increasing as compared to what the Indian government at the centre pays.
These developments, coupled with growing concerns over fiscal discipline, are putting additional pressure on spreads above the respective curve. Given the current trajectory of global risk (high) and domestic risks (relatively low), spreads may continue to look attractive but are likely to continue trading at elevated levels over the operating rate for near future.
How interest rates could move in India
The Reserve Bank of India may adopt an extended pause, allowing it to assess the cumulative impact of past easing. However, the direction of domestic yields may now be increasingly shaped by global dynamics – including the path of U.S. interest rates, trade tariffs impacts, and capital flow trends – rather than domestic inflation-Growth dynamics alone.
How should this impact your thinking on investments
Given that global factors are at play, generally speaking, there could be a shift in focus from high-risk opportunities to defensive opportunities. These are opportunities that offer a compelling balance between yield and duration risk, particularly in an environment where central bank policy appears data-dependent.
Tejas Soman is Chief Investment Officer – Debt, PPFAS Mutual Fund
Disclaimer: The views and opinions expressed in this communication are solely mine and do not necessarily reflect the official policy or position of PPFAS Mutual Fund. Any content provided is for informational purposes only and should not be interpreted as professional or organizational advice.