Just a few days before the budget, Finance Minister Nirmala Sitharaman signalled a shift from the fiscal deficit-to-GDP ratio to a medium-term debt-to-GDP anchor. Although progressive, it also gives the government more room to slow-walk the deficit reduction.
It's also worth noting that this isn't entirely new. The FRBM Act already talks about lowering the debt-to-GDP ratio. And in the real world, the debt comes down by cutting annual deficits. Changing the anchor doesn't change that basic arithmetic.
For bond markets, though, these ratios are sideshows. What matters is the sheer volume of bonds hitting the market and the expectations. If investors expect higher bond supply, rising inflation, or greater risks around growth, fiscal slippage, or policy credibility, bond yields rise, regardless of which fiscal metric the government prefers to anchor to.
For FY27, the central government plans to borrow Rs 17.2 lakh crore, an increase of nearly 18% over the current year. That will trigger higher yields in the coming weeks.
The Yield Curve Tells That the Transmission Is Weak
This increase in borrowing comes at an awkward moment.
Over the past year, the RBI has cut policy rates by 125 basis points, and those cuts have clearly travelled through much of the system. Short-term yields, call money rates, and even treasury bill yields are lower than they were a year ago. Even bank-side transmission has worked almost perfectly. Both lending and deposit rates have eased.
But the story changes at the long end. The 10-year government bond yield is already around 6.7%, almost 10 basis points higher than last year, even after repo rate cuts.
State Bonds - Silent Cause of Rising Yields
Even though the RBI has stepped in to provide liquidity and buy central government bonds, it hasn't really helped bring down long-term interest rates. That's because the RBI isn't allowed to buy state government bonds, which, by the way, are being issued in large amounts right now. It's expected to hit Rs 12.5-lakh-crore gross (and about Rs 9 lakh crore net) this year.
Both central and state government bonds are chasing the same pool of investors, so with so many bonds on offer, especially for the longer tenures, the yields are naturally getting pushed up.
Markets Expect Higher Inflation from Now On
Finally, expectations around inflation and policy have shifted. The RBI's move from an accommodative stance to a neutral one was widely read as signalling that the easing cycle is nearing its end.
The latest MPC minutes reinforced this view, suggesting inflation may be bottoming out while growth is strong. As columnist Tamal Bandyopadhyay said, "The bond market sees the future. The perception is that now inflation has bottomed out, from here it can only go up. The market is also pricing in no further rate cut."
Rupee Depreciation Slows Monetary Transmission
Currency pressures have compounded the problems. Rupee depreciation has forced the RBI to intervene in FX markets, largely by selling dollars, which sucked out the rupee liquidity in the process. When rupee liquidity tightens, banks have fewer surplus cash to buy government bonds, thus pushing yields higher.
Global Factors and GST Rate Cut Fears
External factors have only added to the pressure. Bond yields in developed markets have risen amid concerns about geopolitical effects on inflation and fiscal math, while a rebound in commodity prices has lifted global inflation risk premia.
On top of that, US tariff uncertainty has raised concerns about India's export growth, tax collections, and fiscal stability. After levying 50% tariffs on India, the Indian government announced a GST rate cut in August last year, meant to boost consumption. That triggered fears of revenue loss and higher future borrowing, pushing the 10-year yield sharply higher in a single session.
Bloomberg Index Inclusion Delay
Things got even trickier when India's entry into Bloomberg's Global Aggregate Index was postponed. Investors had been counting on a big wave of foreign money - around $20-25 billion - to flow in. Instead, the inclusion was postponed to mid-2026 for another review. That too has some impact on yields.
Final Take
The bond market is no longer focused on how accommodative policy looks today-it's focused on how much debt it will be asked to absorb tomorrow and how risks around inflation and fiscal slippages are likely to rise alongside.
For an economy already grappling with US tariff uncertainties and a weakening rupee, high borrowing costs are a bigger problem for the government. In the next few months, yields will test policymakers' patience - balancing interest rates, inflation and growth.
Disclaimer: The views expressed in this article are solely those of the author and do not necessarily reflect the opinion of NDTV Profit or its affiliates. Readers are advised to conduct their own research or consult a qualified professional before making any investment or business decisions. NDTV Profit does not guarantee the accuracy, completeness, or reliability of the information presented in this article.
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