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Informist, Friday, Dec. 5, 2025

By Aaryan Khanna

MUMBAI – The Reserve Bank of India seems to have given bond yields a green signal to move lower following the Monetary Policy Committee's December meeting. Bond traders may not have acted on it immediately Friday, but the message was clear: the central bank is infusing liquidity and may continue easing.

The rate-setting panel cut the repo rate to a three-year low of 5.25%, marking the first reduction since June. It also lowered its inflation forecasts for 2025-26 (Apr-Mar) and beyond, with RBI Governor Sanjay Malhotra committing to maintain "low" rates for some time amid below-target CPI inflation. Moreover, the central bank announced it would buy gilts worth INR 1 trillion through open market operation auctions in two tranches in December, the first such measure since May. It will also conduct a three-year dollar-rupee buy-sell swap auction for $5 billion on Dec. 16 to infuse durable liquidity. 

"The RBI delivered on most fronts on Friday, lowering rates as per our expectations and taking pro-liquidity steps, as well as measures to prevent a re-hardening in borrowing costs," said Radhika Rao, executive director and senior economist at DBS Bank.

Ashhish Vaidya, managing director and country treasurer of DBS Bank's Indian unit, still sees the 10-year yield in the 6.40-6.60% range it has traversed over the past two months. While traders agree on the upper end of the band, they now see hope that the lower end of the trading range could fall to 6.35% by February, a level last seen in August.

One could be forgiven for thinking bond traders had expected this largesse heading into the rate decision. After falling as much as 6 basis points to a near three-month low of 6.45%, the 10-year benchmark yield ended only 2 bps lower at 6.49% due to a spate of profit booking. But the market had barely priced in the expectation of a rate cut before the policy. Instead, the muted reaction in the benchmark gilt as well as the most-traded 6.33%, 2035 bond was primarily caused by the fresh sale of INR 320 billion of the 6.48%, 2035 bond at auction Friday, dealers said.

Beyond the pullback, other liquid bonds fared much better. The five-year benchmark gilt yield fell as much as 10 bps, its largest intraday fall since October, and ended 6 bps lower, driven by the rate cut. This was helped by traders' expectations that the MPC could cut rates again in February if inflation remained benign.

"The RBI governor acknowledged that inflation has been low and more importantly, the Monetary Policy Committee did not let high growth dictate the policy...the kind of hawkishness markets had expected with the rate cut was not there," said Nitin Agarwal, head of trading, ANZ Bank India. India's CPI inflation fell to a record low of 0.25% in October while GDP growth rose to a six-quarter high of 8.2% in the September quarter, which RBI Governor Malhotra described as a rare "Goldilocks" period.

LIQUIDITY PERMUTATIONS

What deterred some traders from piling into bonds immediately was the lack of certainty about the central bank's liquidity measures. The ones announced for December were an immediate boost, but questions remained around future actions. While the rate cut had drawn divided views from the market, traders had been unified in expecting large OMO buys in the remainder of the financial year ending March.

Most traders saw a liquidity infusion of up to INR 3 trillion by March, which they had hoped would come through OMOs that would allow them to sell gilts to the RBI. With a dollar-rupee buy-sell swap already announced, traders expect another such auction in Jan-Mar that adds liquidity without benefitting bond traders directly. This would cap the RBI's OMO purchases through auctions to INR 2 trillion, dealers said. 

"To some extent, the market is now saying that because the governor announced the swap auction, that takes away from the total bond buyback amount that could have otherwise happened," ANZ Bank's Agarwal said.  

Durable liquidity has shrunk to INR 3.61 trillion on Nov. 14 from nearly INR 6 trillion in July, the latest RBI data showed. Further outflows are expected in the March quarter due to currency-in-circulation leakage, while advance tax and goods and services tax outflows will deprive banks of much of the benefit of the INR-1.45-trillion liquidity infusion announced Friday.

Moreover, RBI Governor Sanjay Malhotra downplayed the influence of OMO purchases on bond yields in the post-policy press conference and said the tool was primarily for liquidity infusion. He also signalled the central bank was comfortable with the banking system liquidity, in a surplus of less than 1% at times, as long as rate cut transmission continued. Regardless, bonds maturing in up to 10 years would be favoured as liquidity remains in surplus, dealers said.

"With these measures adding about INR 1.45 lakh crore (INR 1.45 trillion) of durable liquidity in a short timeframe, the need for further durable liquidity measures in the next 2-3 months has reduced," Edelweiss Mutual Fund said in a note. "This imparts uncertainty regarding the timing of further OMOs beyond the amount stipulated."
 

BUMPY ROAD ON DEMAND-SUPPLY

Some participants remain cautious despite the RBI putting its best foot forward for bonds on the monetary policy. Market participants see other outstanding issues that may potentially keep gilt yields steady or higher outside of the central bank's ambit, such as unfavourable demand-supply dynamics that persist into 2026. Bond supply from states is likely to increase sharply in Jan-Mar, a seasonal rise that has seen over INR 4 trillion of state bond supply hitting the market. 

Complicating the matters, RBI Governor Malhotra said that term spreads were currently similar to when the policy repo rate was 5.15% in 2019, suggesting the central bank is not unduly worried about capping bond yields. He also denied that the RBI would buy state bonds in OMOs. The spread of some 10-year state bonds has climbed to more than 100 bps over the 10-year benchmark gilt in two separate stretches this year, including at the auction Tuesday. 

"As a trader, you are now at a level where you are being asked to absorb large supply near a cyclically low level of yields at the end of a rate cut cycle," a trading head at a primary dealership said. "The hope of another rate cut is also subdued, and as the governor hinted, term spreads should very much widen with a lower repo rate."

Traders remained hopeful that the RBI would include bonds maturing in over 15 years at the upcoming OMOs, a hope answered by the central bank's inclusion of the 6.67%, 2050 bond in Thursday's auction. Long-term bonds have been a source of much misery and loss for treasuries amid a relentless rise in yields, due to lack of support from traditional investors like life insurers and pension funds. 

What worries market participants is that investors will not be flocking to reinvest the proceeds into government bonds. Banks have been holding securities in excess of statutory liquidity ratio norms for years and have been trimming these holdings since the September quarter. A reduction in regulatory requirements to hold liquid securities starting in April will also push gilt investments out of favour with banks, historically the largest holders of government bonds. 

"Banks are full-up on investments and don't see the reason to buy more. There is a crunch in deposits across the banking system and there is credit demand, which is the first course of action for a bank," a senior treasury official at a large state-owned bank said. "I don't expect yields to run down in the near-term, but slowly fall in the next two months to around 6.35% (on the 10-year gilt yield)."    End

With inputs from Pratiksha

Edited by Akul Nishant Akhoury 

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