Market Outlook: Reserve Bank of India Policy Decision Looms, Bond Yields Show Caution Ahead of Repurchase Rate Hike Bets

Indian Government Bonds Gain Amid Potential Tax Relief Measures

Indian government bonds rose on Thursday as yields eased amid reports of potential tax relief measures for debt investors. However, expectations of a possible repo rate hike by the Reserve Bank of India (RBI) capped gains in bond prices.

The benchmark 6.48% 2035 bond yield declined by 2 basis points (bps) to 7.0033%. The US 10-year Treasury yield eased to 4.48%. Bond yields move inversely to prices.

According to a Reuters report, the Indian government is considering scrapping capital gains tax on foreign portfolio investments (FPIs) in government securities, a move expected to bolster foreign inflows into the domestic debt market. Foreign investors have net purchased $1.4 billion worth of Indian bonds so far this year, even as FPI outflows from Indian equities stood nearly $28 billion.

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Market participants will now focus on the RBI policy decision to be announced on Friday, amid a challenging macroeconomic backdrop, clouded by concerns over the potential impact of the US-Iran war on India's growth and inflation dynamics. Nearly 80% of economists surveyed by Reuters expect the RBI's Monetary Policy Committee (MPC) to maintain the repo rate at current levels of 5.25%, although a growing minority anticipates a 25-bps rate hike.

The Indian rupee has depreciated by more than 5%, while the benchmark 10-year bond yield has risen 34 bps since the US-Israeli war on Iran began on February 28. Meanwhile, hopes of a broader US-Iran peace deal increased after a ceasefire agreement between Israel and Lebanon. Bond prices also found support from softer crude oil prices, with Brent crude falling 0.9% to $96.97 per barrel.

Analysts remain divided over the likelihood of an RBI repo rate hike on June 5. Puneet Pal, Head- Fixed Income, PGIM India Mutual Fund expects RBI MPC to hike policy rates by 25 bps to 5.50%. He expects the benchmark 10-year bond yield to trade in a broad range of 6.85% to 7.25% over the next one month.

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Vineet Agrawal, Co-founder of Jiraaf, expects no change in the repo rate, but believes the RBI's commentary on inflation, liquidity, and future policy flexibility will be more critical. Agrawal advises bond investors against aggressively increasing portfolio duration, recommending a balanced strategy to stay invested in high-quality bonds and prefer short- to medium-duration papers.

Vishal Goenka, Co-founder of IndiaBonds, recommends a defensive positioning on the five-year segment of the government bond yield curve, as it is likely to be least impacted by any RBI policy move. Goenka also suggests 2–3 year AA- and A-rated corporate bonds as a relatively defensive positioning.

Hitesh Suvarna, Economist at JM Financial believes there is no space for policy tightening at this juncture, as uncertainty around the resolution of the West Asia crisis has created headwinds for growth. Suvarna expects 20 bps upward revision in RBI's inflation projection to 4.8% in FY27 while growth is expected to be lowered by 10 bps to 6.8%.