Will India’s sovereign bond market rally after rate cut signals from RBI?

Mumbai: India's sovereign bond market has started the second half of the fiscal with positive developments-a dovish monetary policy tone, lower supply of ultra long-dated papers, and third quarter state borrowing within expected limits.

Still, market participants remain cautious and see limited scope for yields to soften in the near term.

While the Reserve Bank of India (RBI) governor Sanjay Malhotra acknowledged space for a rate cut, the market is unsure about the timing.


Downside pressure on the rupee against the dollar given the looming impact of higher US tariffs may also keep demand for bonds low from foreign portfolio investors, traders said.

"Possibility of a rate cut, ample surplus liquidity, and a lower supply of ultra-long government bonds are all supportive factors. With most negative factors already weeded out and much of the optimism priced in, a meaningful rally may only come once the timing of a rate cut becomes clearer," said Venkatakrishnan Srinivasan, founder and managing partner, Rockfort Fincap.

Market caution is visible in the pricing of the new 10-year bond, which was cut off at about 6.48% yield, 3 basis points below current 10-year paper. Typically, the yield spread is 5-7 bps.

Yield on the current benchmark 10-year bond closed on Monday at 6.52%, 6 bps lower compared to pre-policy level.

With the RBI governor hinting at space for easing further, bond yields are likely to remain supported, said V RC Reddy, head of treasury, Karur Vysya Bank. He sees the 10-year benchmark yield in 6.38-6.40% range this quarter.

ICICI Bank expects the 10-year benchmark to trade between 6.45-6.60% in the near term.

State Loans
Reddy said that states need to spread their borrowings evenly across tenors and adhere to indicative calendars. "Any bunching at the long end or excess issuance may cap the rally. Global bond trends, crude prices, and inflation prints will remain key triggers for yield direction," he said.

State governments and union territories are scheduled to borrow ₹2.8 lakh crore in October-December, according to the indicative calendar released by the Reserve Bank of India on Friday. This is 12% lower compared to previous year's calendar amount.

In H2, states borrowed ₹5 lakh crore, up over 30% YoY. Around 60% of this borrowing was in Q2, where the total supply was slightly more than the indicative calendar. The quantum was also higher compared to historical trends.

At the same time, there was less demand from insurance companies and pension funds, leading to a spike in yields. In some cases, the spread between 10-year G-secs and state bonds widened to nearly 100 bps in August.