Bull Run Ahead: Why Indian Government Bonds Are Poised for a Yield Decline

The Reserve Bank of India (RBI) has orchestrated a subtle yet profound shift in monetary policy, transforming the liquidity landscape and creating a golden opportunity for investors in long-duration government bonds. By unwinding its short dollar positions, aggressively deploying open market operations (OMOs), and adopting a dovish stance, the RBI has set the stage for a further decline in bond yields—particularly in the 10-year segment. Here's why this is a compelling investment thesis.

The RBI's Liquidity Playbook: Reducing Dollar Exposure and Injecting Rupee Liquidity

The RBI's reduction of its net short dollar positions—from a peak of $78 billion in February 2025 to $52.4 billion by April—has been a critical move to stabilize the rupee and reduce forex market pressures. By allowing $7.4 billion in short-term dollar positions to mature without rollover in May, the central bank has minimized its exposure to dollar volatility while freeing up rupee liquidity. This strategy is complemented by aggressive OMO purchases, which have injected ₹2.5 trillion into the banking system since December 2024.

The result? A persistent liquidity surplus in the system, now at ₹1.2 trillion, which has already pushed the weighted average call rate (WACR) below the repo rate. This surplus, combined with the RBI's accommodative stance, creates a tailwind for bond prices.

Why the 10-Year Bond Is the Sweet Spot

The RBI's 50-basis-point rate cut in June 2025 to 5.5%—the largest single cut in years—signaled a clear pivot toward growth support. With inflation projected to remain subdued (3.7% for FY26, below the 4% target), the policy path is set for further easing.

For bond investors, the 10-year government bond yield (currently around 6.2%) is positioned to decline further for three key reasons:

1. Surplus Liquidity and Reduced Forex Intervention:
   As the RBI's forex interventions wane (due to reduced short dollar positions and a stable rupee), the need to sterilize liquidity diminishes. This means the excess rupee liquidity will flow into bond markets, driving yields lower.

2. Maturity Waves and Reinvestment Flows:
   Over ₹20 trillion in government bonds mature in FY26. Investors reinvesting these maturities into longer-dated papers (like the 10-year) will amplify demand, compressing yields.

3. Dovish Policy Signals and Global Backdrop:
   The RBI's shift to an “accommodative” stance and hints of a widened policy corridor (from 50 to 75 bps) signal a prolonged low-rate environment. Meanwhile, the U.S. Federal Reserve's pivot toward rate cuts could ease global dollar pressures, further stabilizing the rupee and reducing carry trade risks.

Investment Strategy: Go Long on 10-Year Bonds

The 10-year Indian government bond is the optimal duration to capture this yield decline. Key entry points and tactics include:

• Direct Bond Purchase:
  Investors can buy 10-year G-sec issues (e.g., 2035 maturity) through primary or secondary markets. A gradual decline in yields from current levels could deliver both price appreciation and carry returns.

• ETF Exposure:
  Consider instruments like the NIFTY GOVT BONDS ETF, which tracks a portfolio of government securities, including the 10-year segment. This offers diversification and liquidity.

• Duration Extension:
  Shift allocations from shorter-dated bonds (e.g., 5-year) to the 10-year, as the yield curve is likely to flatten further as rates stay low.

Risks to Monitor

While the bullish case is strong, investors must remain alert to:
- A sudden spike in inflation (e.g., due to supply shocks or fiscal slippage).
- Global rate hikes or a sharp dollar rebound, which could reignite forex pressures.
- Political uncertainty or delays in fiscal reforms.

Conclusion: A Bullish Call with a Strategic Edge

The RBI's liquidity engineering, dovish policy stance, and the maturing bond pipeline create a compelling case for long positions in 10-year government bonds. With yields likely to trend downward in the next 6–12 months, this is a risk-reward favorable trade.

For conservative investors, a 5–10% allocation to 10-year G-secs via ETFs offers steady returns. Aggressive investors can consider leveraged exposure through derivatives, though they must manage duration risk.

The bottom line? Lock in yields now—before the curve flattens further.

Data as of June 2025. Past performance is not indicative of future results. Consult your financial advisor before making investment decisions.