Summary of this article
States plan to raise more than expected in March quarter
Bond yields are expected to remain under pressure fearing higher supply
States and Union Territories (UTs) are planning to raise up to Rs. 4.99 lakh crore in the March and final quarter of the current financial year, according to a release by the Reserve Bank of India (RBI).
However, this could limit investor demand in the bond market, according to experts.
Market participants were expecting the indicative borrowing plan of states to show around Rs. 4.2- 5 lakh crore. Though the overall borrowing is still within the higher end of market expectations, states are usually known to borrow more than the indicative amount, especially in the final quarter of the year.
In the previous financial year, states borrowed Rs. 4.73 lakh crore in the final quarter. This is likely to dent some long-term investor demand in the bond market.
According to experts, bond yields will continue to remain under pressure, as RBI’s rate-easing cycle is near its end. A fall in bond yields leads to a rise in prices and vice-versa. Also, higher borrowing in the final quarter also comes after states were deterred from borrowing more in the second and the third quarter of the current financial year.
“Demand for state bonds from long-term investors might remain weak heading into Q4 FY26 as its traditional buyers like insurance companies, pension funds, and banks might not exhibit great demand due to regulatory headwinds and slower asset growth,” said Abhishek Kumar, a Securities and Exchange Board of India-registered investment adviser (Sebi RIA).
Some relief could be there for the bond market as the RBI will conduct open market operations (OMOs) to purchase government bonds in January.
The RBI is scheduled to buy another Rs. 1.5 lakh crore of bonds this month, after buying around Rs. 1.5 lakh crore of bonds in December.
However, domestic institutional investors, which form a major chunk of investors in the bond market, are seen tepid in buying bonds even with the RBI’s support, as seen in the divergence in bond yields with the lowering policy rate.
At present, the RBI’s key repo rate is at 5.25 per cent and the 10-year government securities (G-sec) yield is hovering around 6.60 per cent.
This is largely because banks, which form a large part of the institutional demand in government bonds, have not been aggressive in buying as deposits have taken a hit while demand for credit has been rising.
“Bank appetite has been poor also because banking system liquidity is not consistently in significant surplus, so deposit growth does not pick up,” said Gaura Sengupta, chief economist at IDFC First Bank.
The higher state bond borrowing in the March quarter could keep yield spreads for state bonds with G-sec on the higher side. Yield spreads for state bonds maturing in 10-year above the G-sec corresponding yield is already around 80-100 basis points (bps). Some expect state bond spreads to rise by another 3-5 bps during the quarter.
Additionally, investors will also be focusing on the higher redemption pressure in the upcoming financial year.
“Next (financial) year, the issue becomes the fact that the gross supply will be high. That is because redemptions are also high, around Rs. 10 lakh crore centre plus state,” Sengupta said.
Some relief for bond yields could come this month, when Bloomberg is expected to announce whether Indian bonds will be included in its Global Aggregate Index. If India bonds get added in the global index, it could bring around $25-30 billion of fresh inflows in the bond market, and could push bond yields lower.
