RBI May Have To Buy More Bonds To Limit Rise In Borrowing Rates

The Reserve Bank of India in the past two years has bought more bonds than it has in the previous five years combined. Since the beginning of 2025, the Rs. 8 lakh crore of government bonds from the market, and in the current financial year alone, have marked for around Rs. 5 lakh crore worth of bond purchases just through open market operation (OMO) auctions.

However, bond yields have shown few signs of easing in the recent past. The 10-year benchmark government bond (G-sec) yield is currently around 6.65 per cent, at an over three-week high, climbing from lows of around 6.24 per cent in May.

Market participants and experts say that with the Bloomberg Index Services (BISL) deferring inclusion of India’s G-secs in its Global Aggregate Index, the only positive which could limit a rise in borrowing rates for the government is through more bond purchases by the RBI. Experts had pegged around $25-30 billion of fresh flows from foreign portfolio investors (FPIs) into G-secs if the inclusion happened.

“The key support to bonds has been RBI OMO purchases, which are expected to continue. RBI has announced Rs. 1.5 lakh crore OMO purchases in January, and we expect another Rs. 1 lakh crore in February-March 2026,” Gaura Sengupta, chief economist at IDFC First Bank, said. The next OMO auction is scheduled to be held by the RBI on January 22, worth Rs. 50,000 crore.

It must be noted in this context that bond yields have risen despite continuous bond purchases by the RBI as well as rate cuts delivered by the central bank, around 125 basis points in 2025.

There are several factors troubling bond markets, among them is that despite the RBI’s constant infusion of liquidity in the banking system through bond purchases as well as through dollar/rupee buy/sell swaps and other fine-tuning operations, rupee liquidity has not shown much improvement. This is primarily due to the simultaneous dollar sales by the RBI to limit depreciating pressure on the rupee. The rupee has fallen over 5 per cent over the past year, and the RBI’s intervention in the foreign exchange market has drained rupee liquidity from the banking system. Currently, the proxy indicator for liquidity surplus in the banking system is around Rs. 1 lakh crore, much less than 1 per cent of net demand and time liabilities of banks.

Pressure on bonds to continue

Continuing pressure on the rupee due to uncertainties in the global trade and tariff situation, and India’s competitive ability in the short term, added with sales by FPIs, rupee liquidity in the system is expected to remain tight. Market participants said that RBI’s bond purchases could limit the rise in bond yields, but the chances of a fall in bond yields were negligible. This is also as RBI’s rate-easing cycle is seen near its end.

Another major reason for worry for bond market investors is higher borrowing expectations in the upcoming financial year. With redemptions of around Rs. 5 lakh crore due in FY27 on just G-secs, bond yields are seen inching higher.

“Market focus is shifting towards FY27,” Sengupta said. “There is a sharp rise in redemptions for both g-secs and state government bonds, which would keep gross supply on the higher side.”

Experts suggest the gross borrowing of the Centre could be around Rs. 17-18 lakh crore, with another Rs. 12-13 lakh crore borrowing from states and union territories in FY27.

However, market participants see a rise in bond yields in the long-end of the yield curve will be limited, as yields in this segment are already seen as higher than the technical levels. Additionally, some interest from long-term investors in the final quarter of the year is also expected to keep yields in this segment rising further. Currently, the yield spread on the 40-year G-sec over the 10-year bond is at 77 bps.

Comparatively, shorter tenure bonds, which reflect borrowing rates for the market, are expected to rise as most see rate cuts by the RBI to be over for now. This could lead to a flattening in the yield curve, meaning a rise in shorter tenure yields will be more than the rise in longer tenure bonds.

“I think (there will be a) flattening (in yields) over a period of time. If you notice in the last month, the longest end of the curve, it is the 40 or 50-year (G-secs) that has performed,” Marzban Irani, chief investment officer at LIC Mutual Fund, said.