Duration, Discipline and the Debt Playbook for FY26

Equity investors are mostly optimistic about the New Year as they see signs of remarkable earnings growth from the third quarter of the current fiscal year (Q3FY26) onwards. The green shoots were evident even in Q2 results. However, the debt market remains a concern for many as the 10-year benchmark bond yield is staying at an elevated level for long even after the RBI’s cumulative rate cut of 125 basis points in 2025. Certainly, this trend deserves a closer look.

Elevated Bond Yield

Throughout the year (2025), the 10-year benchmark bond yield has moved in the range of 6.24 per cent and 6.85 per cent. Towards the end of December, the bond yield has widened to around 6.6 per cent. It is against textbook. Normally, when the central Bank cuts the repo rate, long-duration bond yield is expected to shrink as the demand and price of the existing high-coupon rate bonds go up.

India-U.S. Trade Treaty

Two pertinent developments that can influence the domestic bond market this New Year are: One, India’s ability to sign a trade agreement with the United States and, two, Bloomberg index inclusion. The most worrying aspect is the absence of a trade deal with the U.S. and the resultant rupee depreciation. Notably, the U.S. accounts for one-fifth of India’s merchandise exports and is a major destination of services export. Such a trade agreement is equally important for the equity segment as well since Indian manufacturers have high exposure to U.S. markets.

Rupee Depreciation

Weakening of the rupee poses a big challenge to debt investors as even a minor depreciation will wipe out their gains, especially for the foreign portfolio investors (FPI). India’s foreign exchange reserves and deft external management are crucial in deciding the value of the local currency. If India is able to sign a trade treaty with the U.S., it will certainly halt the currency depreciation and strengthen the balance of payment position. Definitely, it will help in boosting equity market sentiment, too.

Index Inclusion

The other significant factor is Bloomberg Index inclusion. With the RBI keeping stance neutral, it highlights the fact that the RBI is also cognisant of rising yields at a time when rate cuts have happened and system liquidity is neutral to positive. The RBI’s continued efforts to defend the local currency require further liquidity infusion as foreign exchange intervention largely absorbs durable liquidity in the market. Index inclusion at this juncture would be positive for government bonds as this may not only increase appetite for Indian bonds but may also provide stability to the USD/INR exchange rate.

Growth Stimulus

Second, though Q2FY26 GDP numbers painted a rosy picture, there are some pain points. It appears that further easing is required to maintain GDP growth, boost domestic consumption, and enhance credit growth as there is widespread pessimism that the current economic growth is not broad-based. Thus, along with fiscal measures such as GST rate reduction and personal income-Tax cuts, monetary action is also required to beat external headwinds.

Low Inflation

Third, Consumer Price Index-based inflation is currently under control, and the RBI assumes that this disinflationary trend will continue into 2026, projecting headline inflation within its tolerance limit of 4 per cent during the first half of the next fiscal year (FY27). As a result, a section of investors is optimistic about a further rate cut in the February MPC meeting, which is likely to be positive for a vibrant bond market.

Fiscal Prudence

Needless to say, the Central government’s reduced market borrowing and fiscal consolidation measures are also supportive of bond market performance and FPI inflows. However, at present, the domestic bond market is largely influenced by external developments rather than macroeconomic indicators. Thus, for bond investors, the New Year is largely a mixed bag as there are challenges as well as opportunities.

Disclaimer: The opinions expressed above are of the author and may not reflect the views of DSIJ.