Why have bond yields risen despite RBI’s rate cuts?

According to Care Ratings, the yield curve has steepened, especially at the long end, suggesting that investors expect higher borrowing costs in the future. Their report added that unless external risks like persistent US tariffs or domestic growth shocks emerge, the RBI is unlikely to cut rates again in the short term. In such a case, further policy support might be needed, possibly through more accommodative tools beyond rate cuts.

A Tata Mutual Fund report echoed this sentiment, saying that the bond market interpreted the RBI’s recent policy as prioritising inflation control over economic growth. As a result, the yield curve — which plots interest rates across different bond maturities — steepened, with long-term yields rising more sharply than short-term ones.

GST reform and fiscal concerns

Another major concern that has driven bond yields higher is the central government’s draft proposal to rationalise GST slabs. The current system of four rates — 5 per cent, 12 per cent, 18 per cent, and 28 per cent — may soon be simplified into just two primary slabs: 5 per cent for essential goods and 18 per cent for most others. In addition, a 40 per cent rate is proposed for “sin” or demerit goods.

While the reform aims to simplify the tax structure, markets fear a short-term revenue hit. Estimates suggest that if implemented by Diwali, GST collections could decline by Rs 50,000 to Rs 60,000 crore. This potential revenue shortfall raises the spectre of fiscal slippage, where the government might exceed its targeted fiscal deficit.

Investors are concerned that to make up for this shortfall, the government might need to increase borrowing. An increase in government bond supply would push prices down and yields up — a reaction already visible in recent trading.

To address these market concerns and stabilise bond yields, analysts expect the government and RBI to adjust their borrowing strategy. Care Ratings suggests the government may shift its borrowing from long-term to shorter and medium-term maturities. Additionally, the RBI could step in with Open Market Operations (OMO) or Operation Twist.

Under OMOs, the RBI would buy long-term bonds from the market, reducing supply and bringing down yields. In Operation Twist, the central bank buys long-term bonds and simultaneously sells short-term ones. Both strategies aim to reduce pressure on long-end yields and ensure overall market stability.

No immediate rate cuts likely from RBI

At its latest policy meeting, the RBI’s Monetary Policy Committee (MPC) kept key interest rates unchanged. The Repo Rate stands at 5.50 per cent, the Standing Deposit Facility (SDF) at 5.25 per cent, and the Marginal Standing Facility (MSF) at 5.75 per cent. The RBI maintained its growth forecast at 6.5 per cent, but revised down its inflation forecast for the year to 3.1 per cent, from the earlier estimate of 3.7 per cent. However, the central bank projects inflation to rise again to 4.9 per cent in the first quarter of 2026–27. Given this trajectory, the RBI is unlikely to cut rates any time soon.

Still, if inflation continues to decline steadily, the central bank may shift its stance in the future. That would create room to support growth through rate cuts, which in turn could lead to a rebound in long-duration bonds.