India's Bond Yields on the Verge of a Dip as RBI Steps Up Debt Purchases

The Reserve Bank of India (RBI) has ignited a fresh wave of optimism in bond markets with its announcement of a ₹1.25 lakh crore ($15.6 billion) government securities purchase program in May 2025. This aggressive liquidity injection, part of a broader shift toward forward-looking monetary policy, could send Indian bond yields tumbling further in the coming months.

A Strategic Shift in Liquidity Management

The RBI’s move marks a departure from its historical reliance on reactive adjustments to short-term market signals, such as overnight rates or CD spreads. Instead, the central bank has set a clear target: maintaining a durable liquidity surplus of 1% of banks’ net demand and time liabilities (NDTL)—currently estimated at ₹2 trillion. By mid-2025, this surplus could balloon to ₹5 trillion, according to Citi India economist Samiran Chakraborty.

The May purchases, split into four tranches totaling ₹125 billion, are designed to accelerate the transmission of rate cuts to lending and deposit rates. This liquidity surge aims to ease financial conditions, with the weighted average lending rate potentially dropping below 9% within months—a critical threshold for borrowers and investors alike.

Catalysts for Yield Declines

Several factors are aligning to support falling bond yields:
1. Falling oil prices: Brent crude’s plunge to $60.62 per barrel has eased inflationary pressures, creating a more favorable environment for bonds.
2. Strong investor demand: The 10-year benchmark yield has already fallen to 6.3247%, while a new 10-year bond (6.33% 2035) closed at 6.2940%, signaling robust appetite for government debt. Public sector banks alone purchased ₹241 billion in bonds since late April, amplifying this trend.
3. Monetary tailwinds: The RBI’s accommodative stance, combined with a ₹2 trillion dividend payout to the government in May, will further boost liquidity. Though the dividend’s impact will lag as funds are spent gradually, it reinforces the central bank’s commitment to sustained surplus conditions.

Risks and Limitations

While short-term yields are poised to respond strongly to future rate cuts—potentially by 50 basis points or more—long-term yields face headwinds. The 10-year benchmark could dip below 6.30%, but term premium dynamics may limit further declines. Analysts note that widening spreads between long-term yields and policy rates reflect investor uncertainty about inflation and growth, curbing enthusiasm for extended duration bets.

Meanwhile, the rupee’s stability remains intact, with forecasts calling for only marginal depreciation. Strong forex reserves ($600 billion+) and favorable inflation differentials relative to global peers underpin this resilience, even as U.S. Federal Reserve guidance looms over global capital flows.

Conclusion: A Near-Term Rally, But Challenges Ahead

The RBI’s aggressive liquidity strategy is likely to drive Indian bond yields lower in the short term, with the 10-year yield potentially testing 6.20% as the surplus grows. However, the path for long-term yields remains constrained by term premiums and macroeconomic uncertainty.

Key data points to watch:
- The durable liquidity surplus, expected to hit ₹5 trillion by year-end.
- The weighted average lending rate, projected to fall below 9% as liquidity seeps into credit markets.
- The term spread between 10-year yields and policy rates, which could widen further, limiting gains in longer-dated bonds.

For investors, the near-term opportunity lies in short- to medium-term maturities, where rate cuts will have the most immediate impact. Long-term holders, however, must balance the allure of current yields against the risk of rising term premiums. The RBI’s shift to proactive liquidity management is a bold step—but markets will ultimately test whether this strategy can sustainably lower borrowing costs in an era of global monetary uncertainty.