India's Bond Rally: How the RBI's Liquidity Flood Could Push Yields to 6% by Year-End

Indian 10-year government bond yields have fallen to a three-year low of 6.33% as the Reserve Bank of India (RBI) prepares to inject ₹1.25 lakh crore ($14.68 billion) into the bond market through aggressive open market operations (OMOs) in May 2025. This liquidity surge, part of a broader ₹4 lakh crore ($49.36 billion) fiscal-year target, is reshaping expectations for further yield declines—and testing the resilience of India’s bond market against global headwinds.

The Rally So Far: Liquidity and Lower Inflation Drive Yields Lower

The RBI’s front-loaded OMO strategy has been the primary catalyst for the yield decline. Since late April, yields have dropped 15 basis points (bps) to 6.33%, marking the lowest level since early 2022. This reflects both domestic and external tailwinds:
- Easing Inflation: Core inflation has cooled to 4.5% in April 2025, within the RBI’s target range, reducing pressure for tighter monetary policy.
- Global Calm: U.S. Treasury yields retreated to ~3.6%, easing pressure on India’s currency and bond markets.
- RBI’s Liquidity Flood: Cumulative OMO purchases in fiscal 2026 (April 2025–March 2026) are projected to exceed ₹4 lakh crore, dwarfing pandemic-era bond-buying programs.

The May 2025 OMOs—split into four auctions—aim to push the banking system’s liquidity surplus to 1% of net demand and time liabilities (NDTL), up from 0.6% in late April. Analysts argue this liquidity injection could push yields to 6.0%–6.25% by year-end, assuming the RBI meets its targets.

The Market’s Calculus: Bulls vs. Bears

Bullish Case:
- The RBI’s accommodative stance is “reversing the risk premium” in bond pricing, per Gaura Sen Gupta of IDFC First Bank.
- Lower yields will reduce corporate borrowing costs, potentially boosting capex and hiring.
- A 1% liquidity surplus would accelerate the transmission of the RBI’s 6% repo rate to lending rates, with the weighted average lending rate (WALR) projected to dip below 9% by late 2025.

Bearish Risks:
- Geopolitical Volatility: Cross-border tensions with Pakistan and global oil price swings (Brent crude dipped to $59/barrel in May) could reintroduce uncertainty.
- RBI’s Dollar Position: The central bank’s $64 billion net-short dollar exposure may strain liquidity if it must defend the rupee amid external pressures.
- Fiscal Slippage: A delayed payout of the RBI’s ₹2 trillion dividend to the government could temporarily absorb liquidity.

The Path Ahead: Yields at 6%—But Not Without Hurdles

The RBI’s May OMOs are a critical test of its ability to balance liquidity management with market stability. Key milestones to watch:
1. Liquidity Surplus: Achieving the 1% NDTL target by late 2025 would signal success.
2. Global Spillover: U.S. Federal Reserve policy remains a wildcard; delayed rate cuts or a stronger dollar could pressure Indian yields.
3. Inflation Rebound: A return of core inflation above 5% could force the RBI to pivot toward caution.

Conclusion: A Bull Market, but Guarded

The RBI’s aggressive bond-buying program has set the stage for Indian 10-year yields to fall to 6.0%–6.25% by year-end, provided liquidity targets are met. Analyst consensus leans bullish, with ₹4 lakh crore in OMOs and a 1% liquidity surplus forming the backbone of this outlook.

However, risks loom large. Geopolitical tensions, global rate dynamics, and the RBI’s dollar management could derail progress. Investors should monitor the NDTL surplus metric closely—crossing the 1% threshold would validate the bull case—while keeping a wary eye on inflation and geopolitical flashpoints.

For now, the bond market’s rally is firmly in play, but the path to 6% yields remains a tightrope walk over shifting domestic and global sands.

Data sources: Reserve Bank of India, Bloomberg, IDFC First Bank, Nomura Research.