India's Long-Term Bonds: A Strategic Reassessment Amid Supply Dynamics and Fiscal Uncertainty

The Indian bond market is at a pivotal juncture, where diverging views on long-duration instruments reveal a complex interplay of supply dynamics, fiscal pressures, and evolving investor sentiment. For contrarian investors, this environment presents a compelling case for tactical entry into select long-end segments, where widening yield spreads and structural advantages may outweigh near-term risks.

Diverging Views: Oversupply Concerns vs. Yield Attractiveness

The debate between Bandhan AMC and Bajaj Finserv encapsulates the market’s duality. Suyash Choudhary of Bandhan AMC has adopted a bearish stance, citing oversupply in long-duration bonds and a mismatch between issuance and demand. His firm’s reduction in holdings of the 7.3% 2053 government paper underscores concerns about state-level borrowing surges, particularly in longer maturities [2]. Conversely, Lakshmi Iyer of Bajaj Finserv argues that the current yield spread—7.33% for the 7.3% 2053 bond versus 6.56% for the 10-year benchmark [3]—reflects an attractive risk-reward profile. This 77-basis-point differential, wider than the historical average of 68.3 basis points for the 10-year vs. 2-year spread [5], suggests undervaluation in ultra-long segments.

RBI’s Neutral Stance and Liquidity Measures

The Reserve Bank of India (RBI) has maintained a neutral policy stance, keeping the repo rate at 5.50% amid a revised inflation forecast of 3.1% for FY26 [2]. While this stability supports growth expectations, it has not curbed the upward drift in long-term bond yields. The 10-year yield hit 6.58% in late August 2025, reflecting skepticism about the pace of future rate cuts and concerns over the government’s borrowing program [4]. The RBI’s liquidity injections—such as a 50-basis-point rate cut and a reduced CRR—have stabilized short-end yields but left long-end dynamics to global pressures, including U.S. Treasury trends and FPI outflows [1].

Structural Advantages and Institutional Demand

India’s bond market offers structural advantages that amplify the case for long-duration bonds. The average duration of Indian government bonds (14 years) exceeds that of U.S. Treasuries (7.3 years), reducing refinancing risks and enhancing convexity [5]. Institutional demand is also shifting: pension funds and insurers, drawn by yields above 7%, are increasingly allocating to long-end paper [1]. Foreign investors, despite Q3 2025 outflows, have shown resilience, with net inflows of ₹10,471 crore in August 2025 driven by the widening India-U.S. yield gap [2].

Contrarian Opportunity: Navigating the Yield Curve

The key to unlocking value lies in the yield curve’s shape. While the 10-year vs. 2-year spread remains within historical norms, the 7.3% 2053 bond’s yield premium over the 10-year benchmark signals a mispricing. This divergence arises from two factors:
1. Supply Constraints: State governments’ borrowing in longer maturities has outpaced demand, creating a “buyer’s strike” in ultra-long segments [3].
2. Inflation Expectations: With core inflation stable at 4% and headline inflation at 3.2%, real yields on long-duration bonds are attractive, especially if inflation remains anchored [4].

For investors, this suggests a tactical tilt toward ultra-long bonds, where yields offer a buffer against potential fiscal slippages. The RBI’s exploration of tools like Operation Twist could further stabilize the market, reducing volatility in these segments [4].

Conclusion: Balancing Risks and Rewards

India’s long-term bond market is a study in contrasts: oversupply concerns coexist with yield-driven demand, and fiscal pressures meet structural resilience. For contrarians, the current environment offers a rare alignment of conditions—wider spreads, supportive institutional flows, and a neutral policy backdrop—that justify a selective entry into long-end segments. However, success hinges on active management to navigate near-term liquidity risks and evolving fiscal dynamics. As the RBI and market participants recalibrate to FY26’s challenges, the long-end of the curve may emerge as a haven for patient capital.

Source:
[1] India's Bond Market at a Crossroads: Navigating Fiscal Uncertainty and Global Rate Cut Bets [https://www.ainvest.com/news/india-bond-market-crossroads-navigating-fiscal-uncertainty-global-rate-cut-bets-2508/]
[2] RBI Monetary Policy August 2025 Highlights [https://www.indiabonds.com/bonduni/news/august-2025-rbi-monetary-policy-highlights/]
[3] India 10-Year Government Bond Yield - Quote - Chart [https://tradingeconomics.com/india/government-bond-yield]
[4] RBI's Dilemma: Stabilizing Yields Amid Fiscal Pressures [https://www.ainvest.com/news/rbi-dilemma-stabilizing-yields-fiscal-pressures-policy-uncertainty-india-bond-market-2509/]
[5] A Resilient Indian Fixed Income Market [https://www.lseg.com/en/insights/ftse-russell/a-resilient-indian-fixed-income-market]