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Below the Quote on FYI - Debt Outlook by Puneet Pal, Head Fixed Income, PGIM INDIA Mutual Fund 

Fixed Income Commentary May2025

Bond markets remained by and large stable during the month, marked by heightened geopolitical issues and rising global bond yields. The yield curve steepened with the shorter end of the curve outperforming the longer segment. The 4-5yr maturity segment of the curve outperformed with yields coming down by 15-17 bps while the ultra-long maturity segment underperformed with yields rising by 6-7 bps.The benchmark 10yr bond yield ended the month at 6.27%, lower by 7 bps during the month though off from the intra-month-lows of 6.23%. The shorter segment continued its outperformance on the back of surge in liquidity and market pricing in deeper rate cuts from RBI as inflation is expected to remain below 4% through the end of CY2025.

RBI declared a dividend of Rs. 2.69 lakh crore which will augment the durable liquidity in the system to around Rs. 6 lakh crore, providing support to the shorter end of the curve. The market was expecting a higher dividend between Rs. 3.00 to 3.50 lakh crore but, in a prudent measure, the Central Board of RBI changed the Economic Capital Framework (ECF), widening the Contingency Risk Buffer (CRB) range to 4.5%-7.50%of the RBI’s balance sheet from 5.50%-6.50% earlier.
The central bank adopted 7.5% (upper bound) as the CRB this year. This was part of the periodic review of the Economic Capital Framework outlined by the Bimal Jalan committee in 2019.A new 10yr G-sec was introduced this month, which is trading 5 bps below the current benchmark bond yield. The composite PMI came in at 59.7 compared to 60 for the previous month. CPI inflation came in line with expectations at 3.16% which was the lowest since July 2019. The decline in CPI inflation was led by food inflation which slowed to 2.1% YoY and was the weakest food inflation number since Oct 2021.

Core inflation picked up to the highest in eighteen months coming in at 4.20% YoY, though it was exaggerated by higher gold prices, another measure of core inflation, “super-core inflation” ex-auto fuel & gold remains below 4% at 3.60%. CPI inflation is expected to remain below 4% for the rest of CY2025.WPI inflation also slowed to a 13-month-low of 0.85% against market expectations of 1.50%, lower food and fuel prices led the deceleration in WPI, with food inflation coming in at 2.6%, lowest since Nov 2023.
The January to March quarter GDP came in 7.40%, much higher than the consensus expectations of 6.80%. Gross Value Added(GVA) came in at 6.80% (market consensus 6.40%). Higher growth was led by investments (gross fixed capital formation) at 9.40%and higher contribution from net exports while private consumption softened. GVA was driven by the services sector, which in turn was led by the construction sector. Higher net indirect taxes led to larger than usual gap between GVA and GDP. The GDP deflator moderated to 3.1% and the nominal GDP picked up to 10.80%. The provisional estimates of fiscal deficit for FY25 pegged it at 4.80% (almost Rs.10,000 crore higher than the revised estimates of FY25).Both revenues and expenditure were lower. FY26 fiscal deficit is on track to meet the target of 4.40% as the higher than budgeted RBI dividend providing cushion for any revenue shortfall.
Money market yields trended lower on the back of higher liquidity as 1yr yields were lower by 20-25bps with T-Bill yields and up to 5yr G-sec yield trading below the policy repo rate. The 5yr G-sec yield trading below the repo rate is a first since demonetisation. RBI relaxed investment rules for FPIs in corporate bonds in respect of maximum 30% holding in short tenure bonds and also in respect of the single issuer exposure limits even asFPI flows into FAR securities remained negative though they were positive in other debt segments, resulting in an overall positive FPI debt inflow of USD 1bn for the month of May.
Globally, bond yields stayed elevated on growing fiscal concerns with the benchmark US 10yr bond yield touching an intra-month-high of 4.60% though it ended the month lower at 4.40% up24bps from previous month’s closing.
Going ahead, we expect another 25bps rate cut in the policy repo rate in the June 6th MPC meeting with RBI retaining its above consensus growth forecast of 6.50%  for FY26.  We expect the yield curve to remain steep and expect the belly of the curve ( 5yr-10yr) to outperform going ahead.

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