Mumbai: India’s bond market sees further rate cuts as less likely now, at least according to one indicator.
The gap between India’s 10-year government bond yield and the repo rate is at 96 basis points, close to its widest in two years. This spread expanded as the benchmark yield rose on concerns about the near-term fiscal implications of reducing goods and services tax (GST) slabs to 5% and 18% and moving several categories of products to lower rates.
The yield difference reflects the stage of the rate cycle as spreads are “very narrow” at the start and high towards the end of it, according to Rajkumar Singhal, chief executive of Quest Investment Advisors, an investment advisory firm. “Currently, after having seen deeper rate cuts, the expectation is that going forward, rate cuts will be limited, and that’s why spreads are higher.”
The monetary policy committee of the Reserve Bank of India (RBI) has cut the repo rate by 100 bps since February to 5.5%. Economists expect further rate cuts, citing tariff shock and its potential impact on the economy, Mint reported earlier.
GST relief impact
However, the yield on sovereign paper has been rising since Prime Minister Narendra Modi’s 15 August Independence Day announcement of GST relief. The bond market fears a spike in government borrowing to make up for revenue foregone for the indirect tax cuts.
After rising from 6.4% on 14 August to 6.6% on 26 August, the yields cooled closer to the meeting of the GST Council, according to data from Investing.com. On 3 September, the council decided to retain two GST slabs — 5% and 18% — while abolishing 12% and 28% rates. On 5 September, the yield softened 3 bps from the day before. On 9 September, the 10-year G-sec yield stood at 6.49.
When growth slows and inflation trends down, 10-year G-Sec yields fall first as investors price in upcoming easing, according to Singhal. “The repo cuts follow later, validating what the market has already discounted.”
That’s why a rise in yields now is seen as a signal that the rate-cut cycle may be ending. But it’s not just because of worries about the potential impact of GST rate cuts.
The 10-year government bond yields have not softened after the latest monetary policy, according to Venkatakrishnan Srinivasan, founder and managing partner of financial advisory firm Rockfort Fincap LLP. “The key reason is that the Reserve Bank of India has retained its monetary policy stance as neutral, which led the market to believe that subsequent rate cuts may be delayed in the near term.”
Pressure on the rupee and tariff-related uncertainties have also made investors more cautious about potential inflation risks, according to Srinivasan. The market may want policymakers to take corrective steps such as reducing the supply of ultra-long bonds, cancelling select auctions, or even conducting open-market purchases, he said, adding that such steps would help ease the pressure and bring the 10-year yields lower.
Srinivasan said the recent GST reform initially caused anxiety in the market due to concerns that the government might have to borrow more to cover potential revenue shortfalls. However, it now seems that the actual fiscal impact is smaller than expected, and the government may not need to expand its borrowing programme.
Fiscal outlook
The government has pegged the revenue shortfall from GST cuts at ₹48,000 crore a year based on 2023-24 consumption data. Finance Minister Nirmala Sitharaman told Mint in an interview on 5 September that the expected boost arising from the consumption stimulus will mean that the Centre will retain its budgeted fiscal deficit target of 4.4% this financial year.
Still, the bond market is alert as yields briefly spiked to a recent peak of 6.64% before easing to 6.47% on 29 August, according to data quoted by Srinivasan.
Mataprasad Pandey, vice president at ARETE Capital Service Pvt Ltd, a financial advisory firm, also said that the RBI’s 50-basis-point rate cut suggested that future aggressive easing might be limited, widening the spread between benchmark bond yield and the policy rate.
“This reaction was further intensified by Prime Minister Modi’s announcement of GST 2.0,” Pandey said, adding that while the reform could boost growth, it also raised concerns about higher borrowing needs.
