RBI's Dilemma: Stabilizing Yields Amid Fiscal Pressures and Policy Uncertainty in India's Bond Market

The Reserve Bank of India (RBI) faces a complex balancing act as it navigates rising bond yields, fiscal uncertainties, and evolving market expectations. With the 10-year government bond yield climbing to 6.58% as of August 25, 2025, the central bank must address a confluence of domestic and global pressures while maintaining macroeconomic stability [1]. This challenge is compounded by the government’s recent Goods and Services Tax (GST) reforms, which have introduced fiscal risks and altered investor sentiment [2].

Fiscal Pressures and Market Dynamics

The government’s shift to a two-tier GST structure—reducing tax rates on essential goods and consumer durables—has raised concerns about revenue buoyancy. While the reform aims to stimulate consumption and ease inflationary pressures, it has also heightened fears of a widening fiscal deficit. The fiscal deficit for fiscal year 2024–2025 was already at 4.8% of GDP, and the government’s confidence in meeting its 4.4% target for the current fiscal year hinges on managing these structural risks [2].

Meanwhile, bond yields have surged despite a sharp decline in retail inflation to 1.55% in July 2025, the lowest since 2017. This divergence reflects market skepticism about the RBI’s ability to deliver rate cuts, as evidenced by the yield-repo spread widening to nearly 100 basis points [3]. The spread—a key indicator of market expectations—suggests that investors anticipate prolonged policy caution, even as inflationary pressures recede.

RBI’s Intervention Strategies

To stabilize the bond market, the RBI is exploring a range of tools, including targeted open market operations and Operation Twist—a strategy to buy long-term bonds while selling short-term ones to flatten the yield curve [5]. These measures aim to counteract the buyers’ strike in the market, where institutional investors such as pension funds and insurers have shifted capital to equities amid rising risk aversion [2].

A critical test for the RBI will be its upcoming meeting with bond market participants in September 2025, where discussions are expected to focus on reducing the supply of ultra-long-term bonds (30–50 years) to align with weak demand [1]. Traders have also called for token bond purchases to restore investor confidence, though the central bank must weigh such interventions against the risk of distorting market signals [2].

Market Expectations and Policy Uncertainty

The October Monetary Policy Committee (MPC) meeting will be pivotal in shaping market expectations. While the RBI has signaled a 100-basis-point easing since February 2025, the benefits of these cuts have been muted by external pressures, including high U.S. Treasury yields and geopolitical risks [4]. Market participants are now scrutinizing whether the RBI will allow call or repo rates to drift lower toward the standing deposit facility rate—a move that could enhance bond carry and signal further policy easing [4].

However, the central bank’s hands are tied by the government’s borrowing program, which includes a large debt sale of 320 billion rupees. This supply-side shock threatens to push yields higher, particularly in the ultra-long segment, where yields have surged by 30 basis points in August 2025 [1]. The RBI’s ability to balance fiscal needs with market stability will determine the trajectory of bond yields in the coming months.

Conclusion

India’s bond market stands at a crossroads, with the RBI caught between fiscal pressures, policy uncertainty, and evolving investor behavior. While the central bank has tools to stabilize yields, its interventions must be calibrated to avoid undermining market discipline. The October MPC meeting and the government’s fiscal borrowing plans will be critical in shaping the path forward. For investors, a tactical approach—focusing on high-quality segments and maintaining flexibility—remains prudent amid this volatile environment [5].

**Source:[1] India RBI to meet bond market this week to discuss second half borrowing [https://www.reuters.com/world/india/india-rbi-meet-bond-market-this-week-discuss-second-half-borrowing-sources-say-2025-09-01/][2] India GST rate reform 2025: New two-tier tax structure [https://www.globalvatcompliance.com/globalvatnews/india-gst-rate-reform-2025/][3] India Bond Yields Rise Despite 1.55% Inflation: RBI Rate ... [https://www.jiraaf.com/blogs/bond-insights/bond-yields-rise-despite-low-inflation-india][4] Despite RBI's rate cuts, Indian G-Sec yields remain range bound due to US yield pressures [https://m.economictimes.com/markets/bonds/despite-rbis-rate-cuts-indian-g-sec-yields-remain-range-bound-due-to-us-yield-pressures-says-rajkumar-subramanian/articleshow/122876143.cms][5] How should bond investors position themselves in 'short ... [https://www.livemint.com/market/bonds/how-should-bond-investors-position-themselves-in-short-term-amid-elevated-g-sec-yields-lgt-wealths-doshi-explains-11756553908165.html]