Just days before presenting the Union Budget, Finance Minister Nirmala Sitharaman signalled a shift in India’s fiscal framework, moving away from the traditional fiscal deficit-to-GDP ratio toward a medium-term debt-to-GDP anchor. While the move is seen as progressive and more aligned with global best practices, it also gives the government greater flexibility to slow the pace of deficit reduction.
Importantly, this shift isn’t entirely new. The FRBM Act already mandates a reduction in the debt-to-GDP ratio, and in practical terms, debt can only be lowered by curbing annual fiscal deficits. Changing the anchor does not alter this fundamental arithmetic.
Bond Markets Don’t Care About Anchors — They Care About Supply
For bond investors, fiscal metrics are largely secondary. What truly matters is how many bonds the government is issuing and what risks lie ahead.
If markets anticipate:
- Higher bond supply
- Rising inflation
- Slower growth
- Fiscal slippage
- Weak policy credibility
bond yields will rise—regardless of whether the government prefers a deficit or debt anchor.
For FY27, the central government plans to borrow Rs 17.2 lakh crore, nearly 18% higher than the current year. That surge in borrowing is expected to push yields higher in the coming weeks, and markets have already begun pricing this in.
Yield Curve Shows Monetary Transmission Is Breaking Down
The timing of higher borrowing is awkward.
Over the past year, the RBI has cut policy rates by 125 basis points, and those cuts have transmitted well through most of the system:
- Short-term yields and call money rates are lower
- Treasury bill yields have eased
- Bank lending and deposit rates have softened
However, the long end of the yield curve tells a different story.
Despite rate cuts, the 10-year government bond yield is hovering around 6.7%, almost 10 basis points higher than a year ago, signalling that long-term rates are resisting monetary easing.
State Government Borrowings: The Silent Pressure Point
One key reason long-term yields remain elevated is the surge in state government bond issuance.
While the RBI has stepped in to support liquidity and purchase central government bonds, it is not permitted to buy state government bonds. States are expected to issue around Rs 12.5 lakh crore gross (about Rs 9 lakh crore net) this year.
With both Centre and states competing for the same investor pool, especially at longer maturities, the excess supply is naturally pushing yields higher.
Inflation Expectations Have Turned
Market sentiment around inflation has also shifted.
The RBI’s decision to move from an accommodative stance to a neutral one has been widely interpreted as a signal that the rate-cut cycle is nearing its end. Recent MPC minutes reinforced this view, suggesting that inflation may have bottomed out even as growth remains resilient.
As columnist Tamal Bandyopadhyay put it:
“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 Is Tightening Liquidity
Currency pressures have added another layer of complexity.
To stem rupee depreciation, the RBI has intervened in forex markets by selling dollars. This process drains rupee liquidity, leaving banks with less surplus cash to deploy into government bonds—further pushing yields upward.
Global Pressures and GST Cut Fears Add Fuel
External developments haven’t helped either.
- Rising bond yields in developed markets amid geopolitical uncertainty
- Rebounding commodity prices lifting global inflation risk
- US tariff actions raising concerns over India’s exports and tax revenues
After the US imposed 50% tariffs on India, the government announced a GST rate cut in August last year to support consumption. While growth-positive, the move triggered fears of revenue loss and higher future borrowing, causing the 10-year yield to spike sharply in a single session.
Bloomberg Index Delay Disappoints Investors
Adding to market unease was the postponement of India’s inclusion in Bloomberg’s Global Aggregate Index.
Investors had been expecting $20–25 billion in foreign inflows, but the decision was deferred to mid-2026 for another review, removing a key source of demand for Indian government bonds—at least for now.
Final Take: Debt Absorption Is the Real Test
The bond market is no longer focused on how accommodative policy appears today. Instead, it is looking ahead—at the volume of debt it will be asked to absorb and the rising risks around inflation and fiscal slippage.
With the economy already navigating US tariff uncertainty and a weakening rupee, persistently high borrowing costs pose a serious challenge for policymakers. In the months ahead, bond yields will continue to test the government’s ability to balance growth, inflation control and fiscal discipline.