India's fixed income markets are currently navigating a unique landscape where traditional macroeconomic worries have taken a backseat. The primary forces steering bond yields are now market mechanics, particularly the dynamics of supply and demand. While inflation has receded and monetary policy has turned supportive, government bond yields have remained surprisingly firm. This situation presents a distinct opportunity for informed investors.
The RBI's Calculated Stance and Liquidity Tools
The Reserve Bank of India (RBI) has adopted a clear and cautious approach. With inflation now comfortably below the central bank's target and economic growth holding steady, the policy stance is accommodative but measured. The focus has decisively shifted from aggressive rate cuts to ensuring that existing policy changes are effectively transmitted through the financial system.
To achieve this, the RBI has actively deployed a suite of liquidity management tools. In recent weeks, it has increased its variable rate repo (VRR) operations and conducted open market (OMO) purchases of government bonds. A significant move was the recent announcement of a fresh OMO purchase alongside a USD-INR swap. This combined action sent a powerful signal to the markets, leading to an immediate easing of government bond yields and an improvement in overall sentiment.
The central bank's message is unambiguous: it is prepared to intervene when supply risks threaten to disrupt fundamental stability. By purchasing longer-duration bonds via OMOs, the RBI directly addresses supply-demand imbalances, prevents unintended tightening of financial conditions, and reaffirms its commitment to orderly market functioning. Expectations for further OMO interventions remain strong, especially with central and state government borrowing schedules remaining substantial.
Supply Arithmetic, Not Macro Anxiety
The persistence of higher yields, particularly for longer-tenor bonds, should not be misinterpreted as market stress or a loss of confidence. This firmness is a reflection of simple arithmetic. The market has been faced with heavy issuance across multiple segments:
- Central government bonds
- State development loans (SDLs)
- Paper from public sector undertakings (PSUs)
This deluge of supply has naturally kept term premia—the extra yield investors demand for holding longer-term debt—at elevated levels. This is a pricing adjustment to absorb supply, not a deterioration in India's creditworthiness or macroeconomic fundamentals.
Global developments add a layer of complexity. The US Federal Reserve has begun its easing cycle but remains data-dependent, keeping global bonds sensitive to inflation surprises. Simultaneously, the Bank of Japan's gradual move away from ultra-loose policy has pushed Japanese yields higher, contributing to a global rise in term premia. Even with robust domestic fundamentals, India is not entirely insulated from these international shifts.
A Credit-Led Barbell Strategy for Returns
In this environment, successful fixed income investing is less about making broad bets on the direction of interest rates and more about constructing returns through careful strategy. While duration exposure still offers attractive absolute yields and diversification benefits, gains may be uneven due to supply and global factors.
The clearer opportunity lies in credit-focused strategies, ideally deployed using a barbell framework. This approach balances investments at two ends of the risk spectrum:
At the front end (shorter maturity), high-quality and liquid instruments benefit directly from the RBI's liquidity support. These provide stable income and flexibility for reinvestment. At the longer end, selective exposure to well-priced bonds allows investors to lock in attractive carry as market pressures gradually ease.
Credit emerges as the most consistent driver of returns. High-yielding credits from entities with improving balance sheets, predictable cash flows, and limited near-term refinancing risk are offering compelling spreads. With defaults remaining low and corporate earnings visibility improving, valuations now reward investors who can discriminate between issuers. This is not about blindly chasing yield, but about identifying credits where the underlying fundamentals are quietly strengthening.
The Bottom Line for Investors
India's bond market is not in a fight with the RBI. It is rationally adjusting to a period of heavy supply. The overarching backdrop is favourable for steady income generation: inflation is contained, liquidity is being actively supported through OMOs, VRRs, and swaps, and the central bank has signalled its readiness to act as a stabilizer.
For investors, a pragmatic path forward is a credit-led barbell strategy—anchored in quality at the short end and selective carry at the long end. This approach offers a disciplined way to compound returns while the market absorbs supply and the next phase of monetary policy transmission unfolds.
(Views expressed by Chirag Doshi, CIO of Fixed Income Assets at LGT Wealth India, are for educational purposes. Investors should consult certified experts before making decisions.)
