India's Bond Market Volatility Amid Global and Domestic Dynamics

India's bond market has entered a period of heightened volatility in 2025, driven by a confluence of global macroeconomic shifts and domestic liquidity pressures. As U.S. Treasury yields swing on inflationary fears and India-US trade dynamics remain uncertain, the Reserve Bank of India (RBI) has found itself at the center of a delicate balancing act. Traders and primary dealers are increasingly urging the central bank to step into the secondary market with open market bond purchases (OMO) to stabilize yields and restore investor confidence.

The RBI's Dual Challenge: Supply Glut and Liquidity Constraints

The immediate catalyst for market unease is a persistent supply-demand imbalance. Despite a 100-basis-point rate cut since the start of 2025, demand from long-term investors such as insurers and pension funds has remained weak, leaving the market vulnerable to sharp yield spikes, according to a Reuters report. According to an Economic Times report, traders estimate the RBI could purchase up to ₹1.5 trillion ($17.1 billion) in government debt to offset this imbalance. Recent data underscores the urgency: investors-including the RBI-net bought bonds worth ₹205 billion ($2.31 billion) in a single week, the largest such purchase in nearly five years, according to a Reuters report.

The RBI's interventions have taken two forms. First, it has ramped up secondary market purchases, particularly of maturing 5.15% 2025 government securities, to absorb excess supply. Second, traders have pushed for a shift from the current multiple price bidding system to a uniform pricing method in primary auctions, which would reduce mark-to-market risks for investors, as reported by the Economic Times. While the RBI has not explicitly endorsed these measures, its actions suggest a tacit acknowledgment of market fragility.

Market Implications: A Mixed Bag of Outcomes

The RBI's purchases have provided temporary relief. For instance, the "others" category (including the central bank) has supported bond prices for three consecutive sessions, with secondary market buying hitting ₹142 billion, according to an Economic Times report. However, the market remains wary. Analysts note that if the RBI halts its purchases, yields could rebound sharply, exacerbating liquidity strains, as noted in the Reuters report. This uncertainty is compounded by external factors: a rout in U.S. Treasuries and global inflationary pressures have dampened appetite for Indian bonds, even as the RBI's interventions offer a floor, according to the Reuters report.

The broader macroeconomic context adds complexity. While banking system liquidity has improved, the RBI must navigate conflicting priorities-supporting bond prices without fueling inflation or undermining its recent rate-cutting cycle. As one trader put it, "The RBI is walking a tightrope between market stability and monetary policy credibility," according to a MoneyWire report.

A Broader Strategy: Deepening the Bond Market

Beyond immediate interventions, the RBI is collaborating with the Securities and Exchange Board of India (Sebi) to address structural weaknesses in the bond market. Sebi Chairman Tuhin Kanta Pandey recently highlighted plans to introduce bond derivatives, aiming to attract retail investors and narrow the gap between bank credit (₹91 trillion) and corporate bonds (₹54 trillion), as reported by a Financial Express report. This initiative aligns with the RBI's long-term goal of diversifying funding sources for Indian corporates and reducing reliance on bank loans.

However, progress remains incremental. While bond derivatives could enhance market depth, their impact on short-term volatility is limited. Traders continue to push for clearer signals from the RBI on its OMO strategy, particularly as a key ₹320 billion auction for the 6.48% 2035 bond looms, according to the Economic Times report.

Conclusion: Uncertainty Lingers

The RBI's secondary bond purchases have bought time, but they are not a panacea. Market participants remain divided on whether these actions signal a sustained commitment to yield support or a temporary fix for maturing debt. With global uncertainties persisting and domestic demand for bonds lagging, the central bank faces a critical test of its ability to manage market expectations.

As the bond market awaits further clarity, one thing is clear: India's bond market volatility is a microcosm of the broader challenges facing emerging markets in a fragmented global economy.