Rate cuts came, but bond yields didn't quite follow the script

Indian bond yields have failed to faithfully mirror the reduction of policy rates in the current easing cycle that began a year ago, with experts attributing the rare deviation from precedents to the lack of clarity on a glide path to terminal rates and sustained supply of debt paper, particularly from states. However, transmission of rate cuts is visible in the consuming end of the borrowing spectrum, such as loans taken to buy homes and cars, or run small businesses, central bank data for December showed. Typically, such loans are benchmarked to the repo rate-and are repriced immediately.

"The stance change in June triggered selling in long tenor bonds as markets reassessed growth projections, keeping yields elevated. High state bond supply then pushed yields up further," said Alok Singh, head of treasury at CSB Bank.


Indian policy rates have eased 125 basis points since February 2025 after the current Governor, Sanjay Malhotra, took office in December 2024. But the benchmark yields have barely moved since then, marking an evident departure from previous cycles of policy easing.

One basis point is a hundredth of a percentage point.

In 2020, for instance, yields eased 73 basis points against a repo rate cut of 115 bps, while in 2019 yields eased 119 bps versus a rate cut of 135 bps. In the 2017 rate cut cycle of 200 bps, yields had eased 196 basis points.

But in the current cycle, the 10-year paper that traded between 6.69% and 6.72% in February last year before policy easing began is trading at similar levels a year-and multiple reductions-later.

Retail Borrowing
Reserve Bank of India (RBI) data for December, however, showed that loans benchmarked to external gauges have benefited from transmission.

Rates on fresh loans eased 112 bps to 8.28%, while on outstanding loans rates eased 74 bps to 9.06%. In the same period, rates on fresh deposits eased 82 bps to 5.67%, while outstanding deposit rates eased 34 bps to 6.68%.

Policy rates have been reduced through the past one year to safeguard the economy battling high US tariffs and a global trade slowdown. Yet, the stance was changed to neutral from accommodative in just two months after the June 2025 policy saw a larger than expected 50 bps cut.

"Typically, central banks cut gradually, about 25 bps, and hold the accommodative stance longer. This time they reverted to neutral too quickly," said a treasury head at a large private bank.

While the RBI injected liquidity via open market operations (OMO) and foreign exchange swaps, the surplus in the banking system was not consistent or near the 1% NDTL mark, which exacerbated yields.

"Without a glide path, liquidity becomes crucial. The RBI injected funds but couldn't maintain a sustained surplus, so it offered little support to funding costs or yields," Singh said.

Elevated state government borrowing pushed yields higher, as attractive SDL (state development loans) returns drew fund managers toward state bonds. Supply jumped due to state elections and revenue pressures after GST cuts.

“SDL supply rose sharply, and investors preferred state bonds over central bonds, skewing the demand-supply dynamics,” said Sameer Karyatt, head of trading, DBS Bank India.