Over the past year, India’s bond market has been on a quiet but consequential journey. At first glance, the script seemed straightforward: inflation was easing, growth needed support, and the Reserve Bank of India (RBI) had begun nudging interest rates lower. For bond investors, that usually signals one thing – falling yields and rising prices.
But as we’ve seen, the market had its own plans.
Even as expectations of monetary policy easing gathered pace, bond yields refused to cooperate. Global interest rates stayed higher for longer, government borrowing remained heavy, and investor flows became more cautious. What unfolded instead was a tug-of-war between what domestic policy suggested should happen and what global and supply-side realities demanded.
It’s against this backdrop that a familiar question has resurfaced where are bond yields headed next?
To make sense of where yields might go from here, we need to look back at what has shaped them so far and then follow the trail of clues the market is leaving behind.
The policy paradox: Why rate cuts didn’t help
Earlier in 2025, the RBI front-loaded a series of interest-rate cuts aimed at bolstering growth. The RBI has cut nearly 125 bps in terms of repo rate in CY 2025. Traditionally, lower policy rates push bond yields down implying cheaper credit, cheaper government borrowing, and a more accommodative curve for the economy.
But, despite the RBI’s efforts, bond yields didn’t fall as expected. In fact, the yield on India’s 10-year government bond moved up by a surprising 30 bps, especially after a 50 bps rate cut in June 2025.
What changed? The first signal came from the RBI itself. The central bank shifted its policy stance from “accommodative” to “neutral”. While it’s a subtle change in language, it is indeed an important one for the markets. It suggested that the RBI was becoming more cautious about pushing rates lower. That caution soon translated into action: the RBI paused policy rates for two consecutive meetings before delivering a 25 bps rate cut in December 2025.
For markets, the message was clear. The aggressive easing phase was likely behind us.
In our view, this marks the near end of the rate-cutting cycle – a view that bond markets have largely priced in. By the end of November 2025, the 10-year government bond yield had settled around 6.55%, reflecting a market that was no longer counting on further rate cuts, instead was adjusting to a more stable, neutral rate environment.
In hindsight, the move made perfect sense. Bond yields rose even in a year of rate cuts because the market wasn’t fixated on the last policy decision. It was already looking ahead to what comes next.
And that’s when it became clear: domestic policy alone wasn’t enough to drive yields lower. Global factors, like movements in U.S. Treasury yields, were starting to have an influence too. While the RBI was easing, U.S. Treasury yields remained relatively elevated and for global investors, that played a major role. When overseas bonds start offering attractive returns, even after adjusting for currency hedging costs, the incentive to allocate capital to Indian bonds weakens. As those flows soften, demand for Indian debt eases, and yields face upward pressure.
The supply glut: Why state loans are flooding the market
If demand is one side of the bond equation, supply is the other and this year, supply hasn’t taken a back seat.
India’s borrowing needs, especially from state governments through State Development Loans (SDLs), have stayed elevated throughout 2025. In some of the auctions, demand simply didn’t meet expectations, pushing yields higher as investors sought better returns to compensate for the perceived risks.
A big part of the problem? An excessive supply of SDLs combined with states issuing bonds in multiple maturities at the same time. This created a mismatch between what was being offered and what the market was ready to absorb, leaving bondholders demanding higher yields to take on the extra supply.
As a result, the spread between SDLs and G-Secs (government bonds) has widened beyond its historical averages. In other words, investors are now asking for more yield to take on state debt compared to the safer central government bonds. When these spreads widen, bond yields naturally start to move higher.
This shift in dynamics has become a key talking point in 2025 and is expected to continue shaping the market well into 2026 For bond investors, understanding these supply-demand imbalances will be crucial in predicting how yields will move in the near future.
The currency link: How a weak rupee hurts bonds
It’s not just the domestic factors that are at play here. The Indian rupee (INR) and the flow of foreign investment have also been key drivers of bond yields this year.
When the rupee weakens, it tends to put a damper on foreign appetite for Indian debt. This is especially true when global yields elsewhere remain attractive or stable, making it harder for India to compete for foreign capital. As a result, the demand from Foreign Portfolio Investors (FPIs) has been more subdued in 2025 compared to previous years.
This softness in foreign demand has only added to the local supply pressures, creating a situation where yields have been pushed higher than many markets initially expected. So, while domestic factors like inflation and easing interest rates are important and directionally positive for bond yields, the global investor sentiment and currency fluctuations are proving just as influential on the bond market’s direction.
The near-term verdict: Range-bound volatility?
While the views in the market are divided for next year –
On the more bullish side, one possible outcome could be that of benign inflation and possible rate cuts by the RBI may likely nudge yields mildly lower in the near term, especially if oil prices remain soft and economic growth holds up, taking the benchmark 10-year G-Sec yield around 6.4%–6.5% by late FY 2026.
Other outcomes, however, could be that we may see a range-bound or even elevated yield environment. With global rate pressures, fiscal supply stress, and less enthusiastic demand for SDLs, the market may keep bond yields from collapsing by a phenomenon where supply is outpacing demand.
This mix of factors suggests that bond yields are unlikely to plunge, even if the RBI remains accommodative. It’s not just one force driving yields in either direction; rather, it’s a combination of elements at play. Instead of sharp movements, yields are likely to hover within a broader range, with occasional spikes due to macroeconomic surprises or policy changes. But one thing is clear, though: the RBI is unlikely to hike interest rates in FY2027.
The FY 2027 Outlook: 4 Key Drivers
Looking into FY 2027, the big picture seems to be one of cautious equilibrium rather than dramatic moves:
1. Monetary Policy May Stabilize
With inflation relatively well-anchored (our estimate for FY 27 is ~3.8% YoY) and growth expectations intact (7% real GDP growth), the RBI might be close to the end of its rate-cutting cycle. A stable policy backdrop tends to anchor long yields, preventing sharp declines or hikes without solid economic triggers.
2. Supply and Demand May Have Bigger Roles
The debt calendar for central and state borrowings is likely to be a major driver. If supply levels remain elevated while institutional demand stays cautious, yields could settle slightly above current historical norms to balance the market.
3. Global Cues May Not Be Ignored
The global bond market remains heavily influenced by decisions from the U.S. Federal Reserve, geopolitical uncertainties, and broader yield movements abroad, all of which will continue to ripple through Indian markets. However, there’s a silver lining on the horizon: India’s upcoming inclusion in the Bloomberg Global Aggregate Index.
Set to begin on April 1, 2026, this move is expected to unlock $20-25 billion in foreign inflows over a six-month period1. For Indian bond markets, this means a significant boost in demand for government securities, which could help lower borrowing costs for the government and provide support to the rupee’s stability.
This inclusion signals India’s growing prominence in the global economy and financial markets, making it an attractive destination for international investors. As India’s financial markets become more integrated with global indices, the benefits could be felt not just in the bond markets, but across the broader economy.
4. Investor Expectations May Shift
For retail and institutional investors alike, a moderate expectation might be wise. Yields in the mid to high 6% range for 10-year G-Secs. SDL yields may sit higher still, offering pickier but more compensated opportunities.
What it all means for investors
- While bond yields are unlikely to experience a dramatic drop, you can expect some easing in rates of savings deposits, fixed deposit , and other repo-linked instruments, particularly if policy rates see mild cuts. However, investors may keep in mind that global factors such as trade deals with major economies like the U.S. and India’s borrowing needs (fiscal deficit and its funding) will play just as critical a role in shaping the financial landscape as the RBI’s decisions.
- Diversification is key. With such a nuanced market environment, investors may consider managing risk actively via flexible bond strategies. Depending on their risk appetite and investment horizon, a Dynamic Bond Fund or blend of G-sec and high-quality, short-to-medium term AAA-rated PSU bonds could help capture pockets of opportunity without over-committing to one direction.
Sneha Pandey is Fund Manager for Fixed Income and Multi-Asset Allocation Funds at Quantum AMC
Source: Bloomberg, Reserve Bank Of India
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