Borrowing Without Bruising the Curve in 2026-27

Managing public debt issuance in 2026-27 requires a steadier hand than in 2025-26. When one storm passes, the prudent captain prepares for the next. Local sovereign bond yields faced that first storm in 2025-26. Despite 125 basis points of rate cuts and ₹13 trillion of liquidity support, the 10-year government bond yield remained broadly flat from the onset of the easing cycle. 

Long bond spreads widened relative to 2024-25 and traded at historically elevated levels. State government bond spreads became the market’s recurring discomfort, notwithstanding a few recent smooth auctions.

 

Several factors contributed to this outcome.

Communication around the perceived end of the rate cut cycle at the June Monetary Policy Committee meeting altered expectations decisively. Bond markets are forward-looking, and once the pivot was signalled, repricing was swift. The increase in SDL auction sizes in July-September 2025-26 introduced additional duration supply at an inopportune time, leading to a sharp widening in spreads.

The first-half issuance profile also leaned heavily towards the long end, even as pension funds were rebalancing portfolios towards equities from April 1, 2025. Although the second half corrected this by trimming long-dated supply by nearly 5%, the earlier widening in long-end spreads proved sticky. Recovery since then has been modest.

Supply Calibration
What, then, can the Government of India do to smooth gross supply concerns in 2026-27? The ₹700 billion switch conducted with the central bank was a constructive step. Subsequent market switches will also compress gross issuance in the coming fiscal year.

If an additional ₹250 billion switch is executed before March-end 2025-26, effective gross borrowing could reduce to around ₹16 trillion from the Budget estimate of ₹17.2 trillion. While ₹16 trillion remains sizeable, the optics improve materially versus the headline number.

Issuance composition will matter as much as the aggregate.

Incremental pension flows are likely to return to the long end in 2026-27, given that equity allocation adjustments were largely completed in 2025-26. There appears to be little need to reduce the combined share of 30-, 40- and 50-year bonds below 30%.

The 15-year segment, however, remains problematic. With the present value of individual SDL auctions clustering around 13–14 years, moderating the 15-year government bond supply would help ease duration congestion. Such rebalancing would require greater issuance in the five- to seven-year bucket, contingent on system liquidity.

Liquidity management will therefore be pivotal. The absence of variable-rate reverse repos is supportive for the short end, particularly as March sees tax-related outflows between excise collections from March 7 and goods and services tax outflows until March 21. Short-end government bond yields remain highly sensitive to systemic liquidity. Yet this stealth easing may not persist after the central bank’s dividend transfer to the government in late May.

Recent regulatory changes by the Securities and Exchange Board of India, allowing arbitrage funds relief on statutory liquidity ratio assets below one year, offer the issuer an alternative lever. Front-loading Treasury bill issuance in April-June and July-September 2026-27 could anchor short-term yields without distorting the term structure.

States’ Experimentation
The more difficult challenge remains state government bonds.

The SDL borrowing strategy in 2026-27 should revert to the 2024-25 template, where April-September issuance constituted roughly 40% of full-year supply. The experiment of expanding SDL auction sizes in July-September 2025-26 widened spreads sharply, and those levels have not meaningfully normalised. A lighter first-half SDL calendar would reduce duration indigestion and temper risk premia.

Auction mechanics also warrant review. Moving long-dated government bonds and SDLs from a multiple-price to a uniform-price auction could dampen volatility. Under a uniform-price format, all successful bidders pay the cut-off yield, limiting yield dispersion when even traditional buy-and-hold investors adopt opportunistic bidding strategies.

Open market operations may be harder to justify in 2026-27, given the forward book and evolving liquidity conditions. Yet demand-supply projections indicate a potential gap of around ₹4 trillion that will require incremental sponsorship.

Even if Bloomberg Global Aggregate Index inclusion is announced in June, with implementation from April 2027, inflows may at best approximate ₹1 trillion, leaving a residual ₹3 trillion. That shortfall would necessitate calibrated support, potentially through Operation Twist or discreet secondary market purchases. Recent data already signalled intermittent central bank buying. Continuity in 2026-27 could provide a cost-effective yield backstop without overt balance sheet expansion.

In sum, managing 2026-27 borrowing will hinge on disciplined first-half maturity distribution, a restrained SDL calendar, adequate liquidity, refined auction design and measured communication. The experience of 2025-26 showed that even abundant liquidity cannot offset supply shocks and signalling missteps. The next fiscal year offers an opportunity to recalibrate before the second storm gathers force.