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Informist, Monday, Mar. 2, 2026

 

By Aaryan Khanna

 

NEW DELHI – Government bonds will enjoy the most insulation among Indian asset classes from the aftermath of the US and Israel attack on Iran not only due to macroeconomic factors but also the support from the Reserve Bank of India. An extension of the military conflict may erode some of the fundamentals and put pressure on bonds in the medium term, but investor sentiment should swing back to the fixed income market should the conflict be seen denting India's GDP growth.

 

Saturday, the US and Israel attacked Iran, killing the country's Supreme Leader Ayatollah Ali Hosseini Khamenei. Iran has since retaliated against Israel and targeted US military facilities in the Persian Gulf. Both sides have shown no signs of de-escalation in strikes as of Monday. These have resulted in the closure of the vital Strait of Hormuz leading to a spike in Brent crude oil futures for May delivery by as much as 13.6% Monday to above $82 a barrel. Some oil refining and port facilities in the region have also been shut.

 

Bond traders shrugged off the impact in their first session after the attack. The 10-year gilt yield had risen to an intraday high of 6.71% from 6.66% Friday, but ended at 6.68% Monday. State governments raised over INR 440 billion through bonds at cut-offs similar to those seen last week. Dealers said the rise in crude oil prices would not have any impact on India's inflation or current account deficit if the escalation peters out in a few days, which was the base case for many dealers.

 

If the military conflict ceases within a week, the geopolitical risk premium on Brent crude may unwind by around $10 a barrel, bringing it back to the band seen last month, dealers said. Helping traders' risk appetite was the modest level of India's CPI inflation – at 2.75% in January, below the RBI's 4% target – and current account deficit, at 1.3% of GDP for Oct-Dec. Therefore, as long as the flare-up is short-lived, traders do not see the attacks by the US and Israel or Iran's retaliation bringing about any monetary or fiscal measures in a hurry to support markets or the economy.

 

"The market reaction is not very alarming so far because we are starting with the buffers of low CAD and low inflation," said Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership. "I don't think this is a game changer for the fixed income market because the narrative on monetary and fiscal policy does not change much. Plus, the RBI has also messaged quite strongly on their comfort with yields."

 

RBI-DRIVEN RISK APPETITE

In the base case, traders had not expected any further rate cuts by the RBI's Monetary Policy Committee in the financial year 2026-27 (Apr-Mar), after 125 bps of cuts in 2025. So policymakers are still expected to stand pat on rates, especially with India's GDP growth seen at a comfortable 7.8% in FY26. Traders also believe the RBI has tacitly signalled its discomfort on government bond yields rising by frequently buying gilts.

 

"Right now, the uncertainty around geopolitical activity remains heightened. For demand to firm up, this has to settle down," said Sudarshan Nambiar, head of trading at YES Bank. "While we have seen demand from banks (as witnessed in the weekly auctions), the yield curve has been largely drawing support from the various RBI measures. Weekend escalations have only added to the scepticism."

 

Players in the 'Others' segment of the market – which includes the central bank, insurers, and provident funds – net purchased gilts worth INR 196.03 billion in the secondary market last week, Clearing Corp. of India data showed. About half of these were speculated to be the RBI's purchases, dealers said. Data released Friday showed the central bank net bought gilts worth INR 28.15 billion in the week to Feb. 20 with a gap of only two weeks from its last string of such purchases.

 

The RBI is seen especially protective of the 6.70% yield on the 10-year benchmark gilt to help banks avoid large mark-to-market losses near the financial year-end in March as well as help the Centre borrow cheaply. The government's Oct-Mar borrowing calendar for gilts is scheduled to end Friday. As investors keep to the sidelines gauging the risk from West Asia, it is the expectation of these purchases which is drawing in bond traders, as is easy liquidity. Surplus liquidity in the banking system -- as measured by the RBI's daily net absorption -- has averaged around 1% of banks' net demand and time liabilities in February.

 

"The risk-reward remains attractive for banks since the yields are elevated, with the repo rate at 5.25% and with the 10-year yield at 6.70-6.75%," said Soumyajit Niyogi, director at India Ratings and Research. "It is only if the conflict escalates further or continues for a long time then we can't say how badly it can go – certainly yields above 6.80% are a possibility. But the shock will transmit first into Indian market through the rupee."

 

The RBI has already bought gilts worth over INR 7 trillion in FY26 and its latest speculated heavy lifting has also helped the market bear the brunt of the escalation by the US and Israel, which had been feared over the past few weeks. With the RBI buying bonds, the potential losses in gilts on Monday went to the central bank rather than traders who would have de-risked their portfolios by cutting positions which could have led to a steeper rise in yields, dealers said.

 

RELATIVE VALUE

Some traders felt financial markets have so far under-priced the risk of the disruption to crude oil due to the military conflict in West Asia, through which most of domestic oil demand is fulfilled. This is especially true for India, which imports 87% of its oil requirements. The RBI's cap on yields has also seen some pushback from domestic and foreign investors who would have otherwise liked to pick up gilts at more attractive yields, dealers said.

 

This strategy from the RBI may lead to volatility if the central bank eases the market back to its own feet at the same time that investors get cold feet from increasing escalation in West Asia. In a twist, bonds are still seen relatively immune even to a crude oil shock as relative value kicks in. Nambiar said this scenario is likely to trigger a sell-off more in the stock market rather than in gilts, where investors will eventually park their cash as they look to manage risk.

 

"In the event of oil prices moving towards $90 a barrel, we shall see a dent in demand sending the 10-year g-sec yield back to 6.75%," the YES Bank trading head said. The positive sentiment is also driven by the lack of gilt supply scheduled till the end of March, barring one last auction on Friday for INR 290 billion.

 

Foreign portfolio investors are generally underinvested in Indian government securities relative to their weightage on global bond indices, making the prospect of further outflows unlikely until an extreme scenario that results in capital flight from all emerging markets, dealers said. This too would be only a secondary order impact for bonds, with the first domino to fall being the domestic currency. The RBI's intervention kept the rupee's fall to 0.5% Monday, which ended at a one-month low of 91.47 a dollar.

 

Going by RBI Governor Sanjay Malhotra's recent remarks, bond traders expect an intervention to protect the rupee's value – by selling dollars, a move that drains rupee liquidity – only to lead to further bond buying by the RBI. The domestic unit has already underperformed its peers over the past few months and is relatively undervalued, dealers said. FPIs are seen re-entering the market should the 10-year gilt yield rise to 6.90-7.00% if the turmoil continues for longer than a month and fresh gilt supply in April pushes up yields.

 

"For India - geographically distant but economically exposed - the more relevant question is not whether near-term volatility will rise, but whether such episodes meaningfully alter the country's long-term investment trajectory. History suggests they rarely do," Axis Mutual Fund said in a note Monday.  End

 

Edited by Ashish Shirke

 

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