India’s Government Bond Yields Rise Despite RBI Rate Cuts

India’s 10-year government bond yields increased by about 26 basis points over a month. This happened even though the Reserve Bank of India (RBI) reduced its key policy repo rate by 100 basis points over seven months to 5.50 per cent. The unusual rise in bond yields reflects investor concerns over inflation control and government borrowing plans amid proposed tax reforms.

RBI’s Hawkish Inflation Stance

Despite rate cuts, RBI’s focus remains on controlling inflation. The Monetary Policy Committee kept interest rates steady in its latest meeting. Inflation forecasts were lowered to 3.1 per cent for the year but projected to rise to 4.9 per cent in early 2026–27. This outlook discourages further rate reductions soon. Investors expect borrowing costs to rise, steepening the yield curve, especially for long-term bonds.

Bond Market Reaction and Yield Curve Movement

Typically, bond yields fall when interest rates are cut. However, India’s bond market reacted differently. Rising yields mean falling bond prices due to selling pressure. The yield curve steepened, signalling expectations of higher future borrowing costs. Analysts suggest the market views RBI’s policy as prioritising inflation management over immediate economic growth support.

GST Reform and Fiscal Concerns

The central government’s draft proposal to simplify GST slabs triggered market unease. The plan reduces four rates to two main slabs – 5 per cent for essentials and 18 per cent for most goods, plus a 40 per cent rate for sin goods. This reform may cause a short-term revenue loss of Rs 50,000 to Rs 60,000 crore. The potential fiscal deficit increase raises fears of higher government borrowing, pushing bond yields up further.

Government and RBI Response Strategies

To stabilise yields, analysts expect changes in government borrowing patterns. Shifting from long-term to short- and medium-term debt may reduce pressure on long-end yields. RBI may intervene using Open Market Operations (OMO) to buy long-term bonds or Operation Twist to buy long-term and sell short-term bonds simultaneously. These measures aim to lower yields and maintain market stability.

Outlook on Interest Rates and Growth

RBI’s current stance keeps the repo rate at 5.50 per cent. Growth forecast remains at 6.5 per cent. Inflation is expected to rise again, limiting scope for near-term rate cuts. If inflation declines steadily, RBI may consider easing policy later. Such a move could boost demand for long-duration bonds and reduce yields.

Questions for UPSC:

1. Taking example of India’s bond market in 2025, analyse the impact of central bank policies on government securities yields and economic growth.
2. Examine the role of Goods and Services Tax (GST) reforms in influencing fiscal deficit and government borrowing strategies in India.
3. Discuss in the light of inflation targeting by central banks, how monetary policy can balance between controlling inflation and supporting growth, with suitable examples.
4. Critically discuss the effectiveness of Open Market Operations and Operation Twist as tools of monetary policy in managing bond yield volatility and market stability.

Answer Hints:

1. Taking example of India’s bond market in 2025, analyse the impact of central bank policies on government securities yields and economic growth.

1. RBI cut repo rate by 100 basis points over seven months to 5.50%, aiming to stimulate growth.
2. Despite rate cuts, 10-year government bond yields rose by about 26 basis points, indicating market unease.
3. RBI’s hawkish stance on inflation led to expectations of higher future borrowing costs, steepening the yield curve.
4. Higher bond yields reflect investor concerns about inflation and fiscal deficit, increasing government borrowing costs.
5. Rising yields can dampen economic growth by increasing cost of capital and crowding out private investment.
6. Monetary policy balancing inflation control and growth support influences bond market sentiment and economic trajectory.

2. Examine the role of Goods and Services Tax (GST) reforms in influencing fiscal deficit and government borrowing strategies in India.

1. Proposed GST reform simplifies four slabs into two main rates (5% essentials, 18% others) plus 40% on sin goods.
2. Short-term revenue loss estimated at Rs 50,000 to Rs 60,000 crore due to reduced tax rates on some goods.
3. Revenue shortfall risks fiscal slippage, potentially increasing the fiscal deficit beyond targets.
4. Higher fiscal deficit pressures government to increase borrowing, raising bond supply and yields.
5. Market fears of increased borrowing push bond yields up, impacting debt servicing costs.
6. Government may adjust borrowing strategy (shift to short- and medium-term maturities) to manage yield impact.

3. Discuss in the light of inflation targeting by central banks, how monetary policy can balance between controlling inflation and supporting growth, with suitable examples.

1. Central banks set inflation targets to maintain price stability and anchor expectations (e.g., RBI targeting ~4%).
2. Monetary tightening (rate hikes) controls inflation but may slow economic growth by raising borrowing costs.
3. Monetary easing (rate cuts) supports growth but risks higher inflation if done prematurely.
4. India’s RBI kept rates steady despite cuts earlier, prioritising inflation control amid rising long-term inflation expectations.
5. Yield curve steepening signals market’s anticipation of future inflation and borrowing costs.
6. Effective policy balances timing and magnitude of rate changes to avoid growth shocks or inflation overshoot.

4. Critically discuss the effectiveness of Open Market Operations and Operation Twist as tools of monetary policy in managing bond yield volatility and market stability.

1. Open Market Operations (OMOs) involve RBI buying/selling government bonds to adjust liquidity and influence yields.
2. OMOs reduce bond supply, supporting bond prices and lowering yields, stabilising market sentiment.
3. Operation Twist entails simultaneous purchase of long-term bonds and sale of short-term bonds to flatten yield curve.
4. These tools help manage long-end yields without changing policy rates, providing targeted market intervention.
5. Effectiveness depends on scale, timing, and market expectations; may be limited if fiscal risks dominate.
6. In India’s 2025 context, these tools are expected to mitigate yield spikes amid fiscal concerns but cannot fully offset structural factors.