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Informist, Friday, Jun. 5, 2026

 

By Aaryan Khanna

 

MUMBAI – It was the government and the Reserve Bank of India's co-ordinated action on Friday that overshadowed the actual monetary policy decision for the bond market. Though the Monetary Policy Committee's sanguine commentary and rate hold seemed balanced and a relief as of June, some bond traders remain wary that the lack of pre-emptive rate action might come back to bite their portfolios later in the year.

 

Comments from RBI Governor Sanjay Malhotra Friday successfully dissolved the view that the central bank would use monetary policy to solve a capital account problem, dealers said. The governor did not suggest either in his statement or in the post-policy press conference that the MPC debated a rate hike to defend the rupee. In addition, he did not mention potential rate increases despite repeated warnings of rising prices. The unanimous vote on the rate decision also gave the market comfort that the committee remained some way away from increasing the repo rate from the current 5.25%. 

 

"The tone of the policy was definitely softer than probably the market consensus, despite GDP and inflation forecasts exactly matching our view," a treasury head at a private-sector bank said. "The governor probably didn't utilise some of the words or hawkish guidance that the market was looking out for, describing inflation as matter-of-factly as possible without delving into it too deeply or referring to rate hikes."

 

The consensus view heading into the policy outcome was that MPC would hold the repo rate. However, traders widely expected Malhotra to at least set the stage for a hike in policy rate in response to expectations of rising inflation later in the financial year and some participants were ready for the eventuality on Friday itself. Yields on rate-sensitive gilts tumbled Friday, marking their best day in two months, after the status quo on the repo rate at 5.25%. The five-year benchmark 6.36%, 2031 bond fell by over 15 basis points Monday, despite only a marginal fall in the 10-year benchmark gilt.

 

Most of all, the bond market rejoiced Friday that the RBI did not employ a rate hike in its defence of the rupee. The bevy of measures from the central bank and the government to attract foreign capital also reduced the quantum of rate hikes that some bond traders expect from the MPC in financial year 2026-27 (Apr-Mar).

 

Higher interest rates were seen attracting more foreign portfolio investment. The rupee has tumbled as much as 8% against the dollar this year to a record low of 96.96 per dollar in May despite large RBI dollar sales due to foreign investors exiting Indian markets and expectations of a wider current account deficit.

 

Instead, Malhotra Friday announced concessions for public-sector undertakings to raise bonds in foreign currency and said the RBI would bear the hedging cost of authorised dealer banks when they raise 3-5-year foreign currency non-resident deposits until Sept. 30. The central bank also removed most restrictions on bond investment under the General Route, expanded the Fully Accessible Route, and reduced the timeline to realise export proceeds. Piling on, the government exempted foreign portfolio investors from capital gains and withholding tax on government bonds, also easing rules for equity investment from non-resident Indians and Overseas Citizens of India.

 

It might only be a temporary reprieve, if the war in West Asia continues to remain in suspended animation. Malhotra referred to the uncertainty over the normalisation of supply chains, leading to inflationary pressures in the Indian economy. The RBI also raised its FY27 CPI inflation forecast to 5.1% Friday from 4.6% in April, and retained its guidance on upside risks. With the MPC skipping a rate hike in June, traders are also concerned domestic monetary policy may fall behind and have to react with harsher measures to high inflation – including outsize rate hikes.

 

The underlying inflation makes the case for the repo rate to be hiked as soon as August, dealers said, particularly in the vital Strait of Hormuz remains effectively shut for commercial shipping. The current nominal repo rate is only 5.25%, while CPI inflation is expected to average 5.1% in Jul-Sept and 5.9% in the December quarter, pointing to a negative real rate of interest. This state, where savers are disincentivised while consumption is encouraged, is seen stoking price rise further.

 

In such an environment, traders said bond yields and overnight indexed swap rates will continue to price in a 50-75 basis point repo rate increase until March. This may limit the downside on the five-year gilt yield to 6.50-6.55% from 6.65% Friday. The 10-year gilt yield is also seen falling to only 6.85% from 6.98% Friday.

 

On the other hand, with the MPC slow-playing its policy response, the 10-year bond yield may not rise above 7.05% unless Brent crude futures pop above multi-year highs of $120 a barrel – a level which the bond had approached with crude near $100 a barrel. Rate hikes – if they come by October or December – are not seen threatening gilt yields higher. 

 

"...the view is that some rate hikes will be needed but only to adjust to the higher inflation outlook. Specifically, there is no case to us for using this as any sort of 'currency defence'," Suyash Choudhary, chief investment officer – Fixed Income at Bandhan Asset Management Co., said in a report. "So long as RBI/MPC communication is clear in not letting market expectation overshoot the trajectory, it really doesn't matter to the current level of market yields whether the repo rate is somewhat higher."

 

CATALYSING DEMAND

Outside of the monetary policy response, the regulator may have generated significant demand for bonds from foreign investors, especially as its measures are seen stabilising the rupee's fall, dealers said. The RBI reintroduced the 15- and 40-year tenure gilts to the Fully Accessible Route, which are eligible for inclusion into global bond indices and have no limits for foreign investment. It also added fresh issuances in the 30-year tenure to the Fully Accessible Route for the first time.

 

The government's waiver of the withholding tax of 20% improves FPIs' return on the 10-year bond by around 140 basis points, a material increase. With capital gains taxes gone, Euroclear – a marquee offshore clearinghouse – may also look to introduce trade in India's gilts, provided the RBI accepts. India's bonds have also been recently integrated with global bond trading platform such as MarketAxess and Tradeweb.

 

Bloomberg Index Services sought further efficiencies in India's market infrastructure and improved access when it held off on including India's bonds to its flagship Global Aggregate Index. With these measures in place, the index provider is likely to give the nod for inclusion when it provides its next update in mid-2026. Bets on this inclusion gathered pace Friday and may ultimately drag down the 10-year gilt yield to 6.75%. With the market assuming a 0.7% weight on the massive index, which is tracked by $3 trillion in funds, India is set to receive over $20 billion of passive investments alone. 

 

"Crucially, the expansion of the Fully Accessible Route-bond base opens the door for foreign inflows across longer tenors, while domestic institutions such as banks, insurers, and pension funds remain underinvested," Sneha Pandey, fund manager – fixed income at Quantum Mutual Fund, said. "With the RBI likely to purchase close to INR 5 trillion of gilts via OMOs (open market operations) in the second half of FY27, the demand-supply dynamics for G-secs look materially improved."

 

WORRYWARTS

Though Pandey held onto her view, most traders expect the foreign exchange inflows from the RBI's measures will improve durable liquidity in the Indian banking system. This reduces the need for the central bank to step in with further injections such as bond purchases, which featured prominently in its liquidity management in FY26.

 

Moreover, the long-term bonds added to the Fully Accessible Route are unlikely to attract large inflows, similar to the situation when the 15- and 40-year bonds were dropped from the bucket in July 2024. Without the Bloomberg index inclusion, inflows in the near-term from the measures alone are seen insipid.

 

"The change in taxation and FAR limits for FPI debt investments are more medium-term measures... Moreover, with chances of a rate hike increasing, high credit demand in the system and continuing bond demand and supply mismatch, rising global yields, limited space for further OMOs by RBI could all put a floor for the 10-year bond yield," HDFC Bank said in a note. The bank's analysts see the 10-year gilt at 7.20-7.40% by the year-end.  End

 

US$1 = INR 94.95

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

 

Edited by Deepshikha Bhardwaj

 

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