A resilient Indian fixed income market

Inflation has now returned to the mid-point of the RBI’s target range of 2-6%, allowing the RBI to make its first rate cut since 2020 in February and further cuts in April and June, as Chart 2 shows.  The RBI also lowered inflation and growth forecasts for this fiscal year, given the potential negative impact from US tariffs on India’s exports. An easier monetary policy could help mitigate the negative impact from external demand shocks. 

Higher frequency indicators also show signs of a recovery in domestic demand. Previously, the restrictive monetary policy since 2022 had reduced bank credit growth, as Chart 3 illustrates. Credit growth slowed significantly from its peak level in 2024, though remaining in double-digit growth. Helped by lower rates, the decrease in bank credit growth has stabilized. In addition, on consumption demand, the slowing growth of India’s vehicle sales, especially two-wheeler sales, appears to have troughed in March and the manufacturing PMI also rose further to 58.1 in March.

Even after the recent RBI rate cut, IGB’s yields remain attractive among APAC (as Chart 4 shows. A lower budget deficit could also ease supply pressure. As shown in Chart 5, net issuance pressure has eased more significantly since 2024. India’s fiscal deficit has narrowed from more than 6% of GDP to only 4% in 2023 and 2024. The fiscal deficit target of 4.4% of GDP for FY2025-26, see Chart 6, and reduced debt-to-GDP goal of 50% bode well for a ratings upgrade, as we have discussed in our previous note ^[1] on India capital markets.

Even with further rate cuts, IGB’s yields remain attractive among APAC (6.6% for 7-10y as of April 2025). A lower budget deficit could also ease supply pressure. As shown in Chart 5, net issuance pressure has eased more significantly since 2024. India’s fiscal deficit has narrowed from more than 6% of GDP to only 4% in 2023 and 2024. The fiscal deficit target of 4.4% of GDP for FY2025-26, see Chart 6, and reduced debt-to-GDP goal of 50% bode well for a ratings upgrade, as we have discussed in our previous note^[2] on India capital markets.

The IGB yield curve bear-flattened during the last rate hike cycle and had remained relatively flat since the end of the RBI’s tightening phase in Q1 2023 (Chart 8). Indeed, the yield curve barely steepened despite the first rate cut in February 2025, perhaps suggesting the cycle is expected to be a relatively shallow one given the buoyant growth outlook. The market was expecting the RBI to cut is policy rate to 5.50% by end-2025,   and this has now materialized earlier than expected, after the 50 bp cut on June 6. Even if all other APAC central banks keep their policy rates unchanged going forward, India’s 5.50% policy rate would remain the highest in the region(Chart 7).

Nevertheless, US tariff risks pose some downside risks to India’s growth outlook. As discussed in our latest quarterly APAC Financial Markets Spotlight, although India’s economy is less dependent on external than domestic demand, tariff hikes could have indirect impacts on growth as India’s exports have a stronger tie to the US than to China. The RBI therefore cut the policy rate from 6.25% to 5.50% in April and June, in order to support growth. This uncertainty has led to some teepening of the yield curve since April (Chart 8). 

As discussed in Part 2 of our India financial market series, foreign bond inflows have been strong since 2023, mainly driven by the improved macro backdrop, attractive yields and ongoing global bond index inclusion. Foreign investors have made net purchases of more than INR 1.5 trillion of Indian bonds since the first half of 2023. The FTSE government bond index inclusion for Indian govt bonds - from September 2025 - may fuel further inflows. 

Chart 9 shows the average life and effective duration of the Indian govt bond market, at 7.3 and 14 yrs respectively, are notably longer than the US Treasury market, which has duration of less than 6 yrs and average life of less than 9 yrs  . The long average life of the Indian market also reduces re-financing risks, and the risk of any short term “ maturity wall ”.  Furthermore, with redemption yields now well below average coupons, this gives opportunities for a reduction in debt servicing costs, as bonds mature.

Source: FTSE Russell and LSEG. Data as of April 2025. Please see the end for important legal disclosures.

Local currency, fixed-rate IGBs eligible under the FAR[2] will enter the FTSE EMGBI (EM Government Bond Index), AGBI (Asian Government Bond Index) and APGBI (Asia Pacific Government Bond Index) indices from September 2025. Eligible FAR IGBs account for almost 40% of the FTSE Indian Government Bond Index universe (Chart 10). In terms of index weights, and as estimated in September 2024, India will likely account for 9.35% of the FTSE EMGBI, following China’s 57.9%; and 9.7% of FTSE AGBI, versus China’s 60.2% and Korea’s 14.1%. The inclusion in the EMGBI would make India the second largest weighted country in the FTSE EMGBI index (also see Chart 10).

India’s government bond market continues to evolve, supported by a favorable macroeconomic backdrop, lower inflation, long average life and a more accommodative monetary policy stance. While recent geopolitical tensions and global uncertainties have driven a temporary pullback in foreign inflows, the structural drivers, such as strong domestic demand, fiscal consolidation, and global bond index inclusions, remain intact. 

IGBs offer attractive yields versus regional peers and the RBI is expected to proceed cautiously with rate cuts, awaiting further progress in lowering inflation. As India establishes its position in global fixed income indices, the deepening of its bond market marks a significant step forward in its capital market development.

[1] Part 1 of the India financial markets series see India: A structural growth story. But have valuations run ahead?, Belle Chang and Indrani De, FTSE Russell, January 2025.

Part 2 of the India financial markets series see Indian Financial Markets – an Inflection point in their global role?, Robin Marshall, Belle Chang and Indrani De, FTSE Russell, April 2025.

[2] FAR stands for Fully Accessible Route Indian government bonds.

Strong domestic growth momentum and above target inflation meant the RBI kept its policy rates at 6.50% from May 2020 until February 2025. And given the solid domestic fundamentals, the RBI rate cutting cycle is expected to be a relatively shallow one, compared with other APAC countries. Indeed, we note that although the RBI did cut rates by 50bp on June 6th, as insurance against weaker growth, it also adjusted its monetary stance from “ accommodative “ to “ neutral “ . Nonetheless, lower rates  have placed further downward pressure on IGB yields, as shown in Chart 4.