Despite lower surplus transfer, Indian bond yields could dip further, analysts say

MUMBAI: Indian government bond yields and overnight index swap rates are set to continue their downward trend, as expectations that the central bank will infuse further liquidity and lower interest rates boost investor sentiment, analysts and traders said.

Even the Reserve Bank of India’s lower-than-expected surplus transfer to the government is unlikely to impact demand in the short term and bond yields, which move inversely to prices, could dip further as the June 6 monetary policy decision looms, they added.

This is in contrast to U.S. Treasury yields, which have been climbing recently due to concerns over proposed tariffs on key U.S. trading partners and a rising budget deficit.

The gap between the benchmark 10-year Indian and U.S. bond yields has dropped to a near 21-year low, with investors not anticipating any sharp reversal.

In India, the short end of the yield curve has declined significantly more than the long end, amid relentless liquidity injection, and the steepness is expected to persist, traders said.

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The 10-year bond yield has eased 52 basis points (bps) so far in 2025, whereas the five-year bond yield has dropped 80 bps.

Nomura recommends a long position in the 6.75% 2029 bond with a target of 5.75% in a month, anticipating the spread with the 10-year bond yield to widen to 50 bps from 36 bps currently.

With the RBI focused on economic growth, overnight index swap rates have plummeted, anticipating over 50 bps of rate cuts in the ongoing easing cycle.

The one-year swap rate has registered its most significant inversion against the RBI repo rate in five years.

The RBI has cut the repo rate by 50 bps so far and is expected to cut at least by a similar quantum in the coming months, with Nomura expecting another 100 bps of cuts in 2025.

The RBI has pumped around $100 billion into the banking system over the past six months, the largest amount ever for such a period, using methods such as easing the cash reserve ratio, secondary market debt purchases, foreign exchange swaps, and aggressive open market operations.

IDFC First Bank predicts the impact of the surplus transfer to be evident in liquidity from June to August, deferring the need for debt purchases to October-March.

It anticipates the RBI will purchase bonds worth another 1.6 trillion rupees ($18.83 billion) this fiscal.