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Informist, Tuesday, Jun. 16, 2026

 

By Aaryan Khanna

 

NEW DELHI – India's government bond market has had an underwhelming reaction to the announcement of a peace deal between the US and Iran, which has otherwise boosted financial markets. Traders say there are two reasons for the timid behaviour: good news was being priced in before the announcement, and the lasting impact of the West Asia war on India's fiscal strength and inflation is likely to prove adverse even as normalcy returns after more than three months of conflict.

The 10-year benchmark gilt yield had already fallen around 25 basis points from the recent high of 7.14% in May after steps from the Reserve Bank of India in early June led to bond purchases by foreign portfolio investors and mutual funds. The Monetary Policy Committee's decision to stand pat on the policy repo rate helped. Moreover, traders were largely betting on the war ending soon after recent skirmishes involving the warring parties--the US, Iran, and Israel--did not derail the peace talks and the near-month Brent crude contract fell to a three-month low Friday, before the deal was announced.

 

US President Donald Trump announced the agreement on a peace deal document late Sunday, with confirmations from Iran and mediator Pakistan following soon after. The 10-year benchmark gilt yield fell less than 3 basis points to 6.87%, though the closing level was the lowest in two months. The one- and five-year overnight indexed swap rates also fell to multi-month lows Monday, but only declined 4 bps to 5.93% and 2 bps to 6.32% on the day, respectively.

 

"The market had already begun to factor in a de-escalation of the Middle East crisis, with risk premia largely reflecting concerns around crude supply disruption," Sameer Karyatt, managing director and head of trading at DBS Bank India, said. "The RBI's MPC maintaining the status quo in June, alongside the RBI's supportive measures for the dollar–rupee outlook, contributed to an easing in Indian government bond yields and overnight indexed swap rates. This likely explains the relatively subdued reaction in (gilts) and OIS rates following the announcement of the US–Iran peace agreement."

 

To be sure, the peace deal is likely to lead to greater FPI inflows into India's bond markets, already at $2.17 billion so far in June. The pace is at a 15-month high after the government exempted foreign investments into government securities from capital gains and withholding taxes. The 10-year gilt's yield tested the psychologically crucial 6.85% yield level Monday but could not dip below it because of a spurt in profit taking from those who had bought over the past three months. Should FPI purchases persist, as expected, the 10-year bond's yield may inch down to the 6.75-6.80% range, bond market dealers said.

 

But the medium-term impact of the war persists, limiting the downside in yields from current levels. The Brent crude futures contract for August delivery has slipped below $82 per barrel before the peace deal has been signed, with optimism on supplies reviving and transit through the Strait of Hormuz being ramped up. However, global oil prices are unlikely to fall sustainably below the current levels because several countries are expected to replenish their crude oil reserves as supplies normalise after having used emergency inventories during the block on one of the world's most important energy corridors, economists at YES Bank and IDFC FIRST Bank said in reports.

 

Higher commodity prices and a logjam in supply chains have also led to domestic price pressures. Wholesale prices in India rose at the quickest pace in at least 26 months in May, mainly because of high fuel prices, according to the new WPI series released Monday by the commerce ministry. The index rose 9.68% on year in May. Some of this is likely to translate to retail prices over the next few months, dealers said. The RBI sees CPI inflation averaging 5.1% in the financial year 2026-27 (Apr-Mar), above its medium-term target of 4%. The expected rate hikes of 50-75 bps from the current 5.25% should set a floor for gilt yields even if other positives play out, dealers said.

Beyond that, fiscal arithmetic has added a tail risk of extra borrowing in the current financial year after two straight years when the actual government bond supply has been lower than initial Budget estimates. Despite a bilateral gilt switch with the RBI bringing down repayments in FY27, the gilt issuance target of INR 16.09 trillion is still a record. Investors are also staring at higher state government supply approaching 80% of the Centre's issuance. 

 

The government's subsidy burden on fertilisers alone is likely to double to INR 3.4 trillion in FY27, a top finance ministry official said last week, though the pressure may come down with commodity prices easing after the peace deal. The Centre had also slashed excise duty on retail prices of petrol and diesel since March, effectively forgoing INR 1.23 trillion in revenue, the official said. It has mitigated the impact through additional duties and boosting divestments in state-owned undertakings in public markets, but latest data showed April's fiscal deficit had doubled from the previous year to INR 3.623 trillion.

 

"We were at around 6.65% (yield on the 10-year benchmark) before the war started," a trading head at a primary dealership said. "A premium of 15-20 basis points over that is a fair level for the market to settle at, considering what has already transpired on the fiscal side and with rate hikes still in the pipeline."

 

INDEX BLESSING

With the narrative of the war largely factored in for now, the next downward movement in gilt yields is seen coming from India's inclusion on the flagship Global Aggregate bond index of Bloomberg Index Services, dealers said. The expected inflows of over $20 billion from passive investors will take time to materialise, but a decline in global bond yields and rate hike worries with the war ending could spur more active FPIs front-running the index inclusion, according to traders.

 

"I think it becomes difficult to sell a lot when you are expecting something like Bloomberg (index inclusion) to happen any time," a senior treasury official at a state-owned bank said. "Though we have some of the trading portfolio to churn at these levels but we are also aware that more flows can come in and so we will want to capture that as well."

 

The index provider said it would provide an update on its decision in mid-2026, with the market expecting an announcement in the remainder of June or early July. Recent steps from both the government and regulators were aimed at securing India's inclusion on the index and are likely to be successful, dealers said. 

 

Moreover, RBI concessions on banks' 3- to 5-year foreign currency non-resident deposits are expected to drive in around $50 billion of liabilities into the banking system by Sept. 30. This inflow is seen being deployed to meet robust credit demand with a spillover likely into investing in short-term gilts. Even with the double delight, DBS Bank's trading head sees the risk-reward trade-off for investors becoming less favourable below 6.75% yield on the 10-year benchmark gilt and below 6.20% on the five-year OIS rate, around 10 bps lower than current levels.

 

"We anticipate some steepening of the bond yield curve and a tightening in asset swap spreads as inflows materialise into India's debt market, supported by FNCR(B) deposits and the potential inclusion in Bloomberg's Global Aggregate Index. However, some of these inflows may not be immediate, and markets are likely to remain cautious about rising inflation later in the year," Karyatt said.  End

 

US$1 = INR 94.56

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

 

Edited by Rajeev Pai

 

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