Betting on Indian Government Bonds: A Contrarian Play in a Post-Selloff Landscape

The recent three-day selloff in Indian government bonds (G-Secs) pushed yields to multi-week highs, creating a rare opportunity for contrarian investors. While short-term volatility has spooked some market participants, the underlying macroeconomic fundamentals—soaring liquidity, benign inflation, and a dovish RBI—suggest a strategic long position in mid-to-long-term bonds could deliver outsized returns. Let's unpack the data and technicals to understand why now is the time to buy.

The Selloff: A Catalyst for Contrarian Value

The RBI's June 2025 policy shift to a neutral stance, paired with a 50-basis-point rate cut, initially spooked bond markets. Yields surged, with the 10-year benchmark hitting a three-week high of 6.29% on June 6 (see ). Analysts attributed the selloff to weak demand for state debt at auctions and lingering uncertainty about the RBI's pause in aggressive easing. However, this panic-driven move has created a mispricing opportunity.

Macroeconomic Fundamentals: A Tailwind for Bonds

1. Inflation at a Six-Year Low

Headline CPI inflation dropped to 3.2% in April 2025, the lowest since 2019, with food inflation easing to a 42-month low of 2.1%. This benign backdrop gives the RBI room to maintain accommodative policies. The central bank revised its FY2026 inflation forecast to 3.7%, well below its 4% target. With core inflation stable, real yields (nominal yield minus inflation) have compressed, making bonds more attractive.

2. Liquidity Surplus at ₹1.7 Trillion

The RBI's cumulative 100-basis-point CRR cut injected ₹2.5 trillion of durable liquidity into the banking system. This, coupled with a near-term forex surplus of $691.5 billion, has kept short-term rates anchored. The weighted average call rate (WACR) fell to 5.83% in May, reflecting ample liquidity. Traders note this surplus will persist through Q3 2025, supporting bond prices.

3. RBI's Dovish Bias

While the RBI adopted a neutral stance, its actions—including open market operations and variable rate reverse repo auctions—signal a preference for liquidity management over rate hikes. Analysts at SBI Research project a 25-basis-point cut by October 2025 if inflation stays subdued. This forward guidance has anchored expectations, even as markets digest the recent selloff.

Technical Indicators: A Bottoming Out?

Yield Spread Dynamics

The 5-year vs. 10-year yield spread has widened to a 35-basis-point premium for the latter—the highest in three years. This steepening curve reflects lagged pricing of the easing cycle at the long end. Vikas Garg of Invesco Mutual Fund notes this creates a compelling entry point for 5–15-year bonds, with the 10-year yield likely to fall toward 6.00% by year-end.

Demand-Supply Dynamics

Weak auction results for ultra-long securities (e.g., 32-year bonds) pressured yields earlier, but demand for mid-term bonds remains robust. PSU banks and insurers, flush with liquidity, are buyers of 5–10-year G-Secs, providing a floor under prices.

Valuation: Cheapening at the Long End

The 10-year G-Sec now yields 6.18%–6.25%, down from its June 6 high of 6.29%, while the 5-year yield has dropped to 5.81%. This compression reflects improved risk-reward at the long end. Historically, the 10-year yield has averaged 6.40% over the past decade, suggesting current levels are attractively priced.

Liquidity and Risks to Consider

Liquidity Advantage

Mid-term bonds (5–10 years) offer superior liquidity compared to ultra-long maturities, which face thin trading volumes. The 10-year G-Sec's daily turnover exceeds ₹200 billion, making it a safer bet for portfolio managers.

Geopolitical Risks

Global factors like U.S. rate policy and trade tensions could pressure yields temporarily. However, India's strong forex reserves and low external debt mitigate these risks. The RBI's forward dollar book, which had caused liquidity concerns earlier, is now well-managed, reducing systemic instability.

Investment Thesis: Go Long on 5–10 Year G-Secs

The contrarian opportunity lies in buying 5–10 year G-Secs at current yields. Key catalysts include:
- Inflation staying below 4%, allowing the RBI to keep rates low.
- Liquidity surplus persisting through 2025, with the CRR cut's impact still unfolding.
- Valuation discounts at the long end versus historical averages.

Avoid ultra-long maturities (e.g., 30-year bonds) due to liquidity risks. Instead, focus on the 10-year benchmark, which offers a 35-basis-point premium over the 5-year bond—a steepening curve bet.

Final Take

The selloff has overcorrected, pricing in pessimism about the RBI's neutral stance. In reality, the macro backdrop—low inflation, ample liquidity, and a data-dependent central bank—supports a bull case for bonds. For contrarians, now is the time to buy the dip in mid-term G-Secs. As Garg of Invesco puts it, “The worst is behind us; the yield curve is your friend.”

Invest wisely, and let the data lead.