Monetary Policy and Yield Outlook : Risk, Rates, and the Unknown - A Bond Market Story By SBICAPS
The complexity of the world in which we live exceeds our capacity to fully comprehend it—especially in the financial realm. We often speak of risk with a sense of familiarity, yet seldom do we confront the deeper, more elusive force: uncertainty. In a bold and unconventional move, the RBI is rewriting the playbook—cutting rates even as the INR depreciates, while simultaneously stacking up a massive FX forward sales position amidst low interest rate differentials. This dual-action strategy marks a shift from tradition, signalling not just agility, but a willingness to walk the tightrope between growth support and currency stability. It’s a fascinating dance of liquidity and leverage in a market where timing is everything.
RBI cuts repo rate by 25bps to 6.00% in line with market expectations, changes stance to “Accommodative”
The RBI’s MPC unanimously resolved to reduce the repo rate. The stance was altered to “Accommodative” with RBI Governor stating that it signals the intended direction of policy rates going forward, i.e., barring any shocks, the MPC is considering only “status quo” or “cut” in future policy meetings. He clarified that the stance is not associated with liquidity conditions. With the RBI offering a clear trajectory for a benign rate path, and real rates high at 2% (repo – FY26 projection CPI), we expect 50-75 bps of additional rate cuts in CY25
Inflation concerns recede into the horizon as global commodity crash ensues
Consumer prices seem to be firmly on the path downward, with Feb’25’s sub-4% print inspiring confidence. Food inflation is likely to ease on a high base, aided by record grain output. Fuel prices have remained steady through FY25, and the recent dip in Brent adds to the optimism. Core inflation appears to have bottomed out, with soft global commodity prices offering support. However, risks remain: currency depreciation, supply chain disruptions, or a spike in oil or food prices could still throw a wrench in the disinflation narrative
Tariff tantrum likely to hurt global growth, doubling down on domestic levels using comfortable fiscals essential for India
Global trade is set to slow, with the US and Europe likely heading into a downturn by end-CY25. While India’s low export dependence offers resilience, global uncertainty may weigh on private capex and dampen momentum in IT services and GCCs. Still, India remains competitively placed—services remain outside tariff walls, and goods like electronics and textiles potentially benefit from a favourable differential in duties. Domestic demand stays strong, underpinning our FY26 GDP forecast of 6.2% real and 9% nominal growth (below NSO estimates). With fiscal consolidation on track, the government retains headroom for targeted stimulus, as already demonstrated in FY25.
External position is manageable as multiple factors delink currency movements from yields
INR pulled back its depreciation on the back of DXY weakness, strong domestic fundamentals, and timely RBI support. Despite this recovery, rising EM risks and volatile capital flows point to a likely trend of gradual depreciation ahead, with FII debt inflows, ECB inflows also expected to moderate from the highs seen in FY25.
RBI unleashes its full toolkit for liquidity management, ensuring effective transmission of rates
Liquidity, in deficit for much of Q1CY25, flipped to surplus in Apr’25. This is as the RBI has undertaken substantial market interventions, with net OMO purchases of ~Rs. 2.6 trn and G-sec buybacks of Rs. 1.2 trn—among the highest historically. This sharp reversal eased funding pressures, pulling short-end rates lower, with T-bill yields and TREPS rate below the repo rate and the 10Y Union G-sec benchmark hovering ~6.50%. While the RBI seems to have won this round, unwinding of large forward positions (which is already in progress) could pressure liquidity and the INR a bit in the near term. Further, improved liquidity, softening growth, and lower rates would lead to lower bank deposit rates from late Q1FY26
Yield to tend downwards, with currency and liquidity acting as brake and accelerator
The decline in 10Y Union G-sec bond yields to ~6.50% reflects easing rate expectations, supported by surplus banking system liquidity, which has driven a sharp drop in short-term yields. With inflation moderating and growth risks persisting, the RBI is likely to institute 50-75 bps of additional rate cuts in CY25 besides existing cuts. However, the broader outlook remains sensitive to currency volatility and the RBI’s participation through OMOs. Given the higher risk premium, credit spreads—especially for AA-rated and below bonds—may widen slightly compared to last year as investors demand higher risk premia
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