India Bond Yields Come Under Pressure Amid Rate and Fiscal Concerns

Indian Bond Yields Continue to Rise Amid Interest-Rate Hike Concerns

The recent surge in Indian bond yields shows no signs of abating as investors weigh the prospects of interest-rate hikes and growing concerns over the government's fiscal position. The benchmark 10-year yield has risen by about 34 basis points to 7% since the outbreak of the Iran war three months ago.

IndusInd Bank Ltd. expects the 10-year yield to touch 7.45% by the end of 2026, while Kotak Mahindra Bank Ltd. sees it trading in a range of 6.8%-7.4% until March. The Reserve Bank of India (RBI) may be under pressure to raise borrowing costs in its decision due Friday, as a weaker rupee and higher oil costs fuel inflation concerns.

The RBI's decision is closely watched by investors, with most economists expecting it to keep rates unchanged for now. However, investors will be looking for signs that the central bank is turning hawkish. Tata Asset Management Pvt. and Bandhan AMC Ltd. expect about 75-100 basis points of rate hikes in the current cycle.

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India is not alone in facing bond selloff from the Iran war and energy disruptions. However, the country is particularly vulnerable given its heavy oil imports and extensive government subsidies on fuel and fertilizers. The government's fiscal position is also under scrutiny, with lower government revenues and higher subsidies expected to widen the fiscal deficit to 4.6% of the gross domestic product in the current fiscal year.

The RBI's decision will be influenced by the government's fiscal position, with Kotak Mahindra Bank predicting that the fiscal deficit could widen to 4.8% in a more adverse scenario. Some money managers, including ICICI Prudential Asset Management Co. and Quantum Asset Management Co. Pvt., expect the RBI to be cautious on rate hikes, given inflation stems from supply-side shocks in energy rather than demand.

The bond market is currently pricing in a prolonged inflation scare, with derivatives markets pricing in aggressive rate hikes. The five-year interest-rate swap has risen over 60 basis points since the outbreak of the war, while shorter government bonds are bearing the brunt of the selloff, with the five-year tenor rising 54 basis points.

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The oil shock has coincided with record foreign outflows from equities, pushing the rupee toward record lows and prompting currency-market interventions from the monetary authority. Radhika Rao, senior economist at DBS Bank Ltd. in Singapore, said that India's bond yields are being shaped by prolonged geopolitical uncertainty, which is affecting fiscal expectations, alongside elevated global yields and a weaker rupee.