Ten-Year Yield May Drift To 7.25-7.50% By March

Government securities should find near-term respite from rupee stabilisation, but the 10-year yield could drift towards the 7.25-7.50% range by March 2027 amid looming fiscal risks and the anticipated turn in the monetary policy cycle in India as well as the US.

The Reserve Bank of India has chosen not to use interest rates as the first line of defence for the rupee, and that should help avoid an immediate monetary policy shock. But it does not remove the upside risks to yields as it only pushes the focus to the second half of 2026-27, when inflation pressures, fiscal uncertainty and rate expectations are likely to become more binding.

In line with market expectations, the RBI maintained a complete status quo on monetary policy. The repo rate was retained at 5.25%, unchanged since December 2025, and the policy stance remained neutral, unchanged since June 2025.

The action lay elsewhere, with the central bank using the policy as a platform to unveil measures to support the rupee and the balance of payments. The April curbs on speculative trading had only limited success, as pressure from the balance-of-payments deficit soon reasserted itself on the rupee. The latest announcements take a different approach, combining durable and short-term measures to support capital flows.

The short-term measures include concessional foreign exchange swaps for public sector undertakings raising external commercial borrowings and full hedging-cost support for banks raising fresh three-to-five-year FCNR(B) deposits. Both facilities are valid until September 30, 2026. The RBI also restored the period for realisation of export proceeds to nine months from 15 months.

The durable measures are more structural, and the Fully Accessible Route basket will be widened to include all fresh issuances of 15-year, 30-year and 40-year government securities. Short-term investment and concentration limits on foreign portfolio investment in government securities under the general route will be removed. Limits for investment by non-resident Indians and overseas citizens of India in listed equity instruments without SEBI registration will be increased, with the same facility extended to persons resident outside India.

These measures, along with capital gains tax benefits provided by the government, should help attract foreign capital, stabilise the balance of payments, and calm both the rupee and government bond yields in the near term. Preliminary estimates suggest scope for $30 billion-$50 billion of fresh inflows by the end of the second quarter of 2026-27. But this may not result in runaway appreciation in the rupee, as the RBI could use the opportunity to recoup its lost reserves.

This is why an interest-rate defence of the rupee is likely to remain a policy tool of last resort for now. The economy is marked by a negative output gap and a weak BoP position, and since the BoP-accretive measures are likely to be productive in the near term, there is limited scope for rupee-related monetary policy tightening immediately.

Having said that, the Monetary Policy Committee could get into action mode in the second half of 2026-27. Shocks from the three Fs--fuel, fertiliser and food--could accentuate price pressures later in the year and the CPI Our consumer inflation estimate for 2026-27 stands at 5.5%, higher than the RBI’s projection of 5.1%.

Although these pressures would be led predominantly by non-core drivers, core inflation could also move up through greater transmission and remain sticky thereafter, especially considering the impending Eighth Pay Commission payout in 2027-28.

As such, the rate-hike cycle could start from October 2026, by when there should be clearer visibility on the outcome of the policy announcements and the monsoon performance. There is scope for cumulative monetary tightening of 50-75 basis points before March 2027. This would also be broadly in line with current market expectations of one to two rate hikes from the US Federal Reserve over the next 12 months.

The government bond view follows from this macro assessment. Until September 2026, liquidity from scheduled government security redemptions of 940 billion rupees, the record RBI dividend of 2.866 trillion rupees, and the likelihood of a short-term boost from foreign debt inflows could keep liquidity conditions comfortable and sentiment broadly supportive.

But as upside risks intensify in the second half of 2026-27, and as market participants start focusing on the impact of the Eighth Pay Commission on the 2027-28 fiscal trajectory, yields are expected to drift higher. Fiscal uncertainty continues to loom because of a likely spike in the subsidy bill, tax cuts, and rising commitments on cash transfers by several states.

The RBI’s package can buy time for the rupee and give bonds near-term relief. It is unlikely to be enough to cap the 10-year yield through March. As monetary policy, inflation and fiscal risks reassert themselves, the 10-year government security yield could move towards 7.25-7.50% by March 2027.