Topic 2: DEBT: TAXING BILL

In July 2025, the Indian debt market exhibited a generally stable yet cautious performance, reflecting the interplay between supportive domestic fundamentals and a challenging global environment. Throughout the month, bond yields on Indian G-secs and high-grade corporate bonds remained largely range-bound, with longer- onger-duration papers—particularly those in the 30–40 year segment—attracting steady investor interest and trading near 7% yields. This relative stability was underpinned by robust domestic liquidity conditions, especially following the Reserve Bank of India’s (RBI) proactive policy measures. After cutting policy rates by 50 basis points in June and reducing the cash reserve ratio by 1% (infusing roughly ₹2.5 trillion of liquidity), the RBI shifted to a “neutral” stance in July, signalling that further rate cuts were unlikely without a continued and broad-based decline in inflation. Consequently, short-term money market rates, including Treasury Bills and AAA PSU Commercial Papers and Certificates of Deposit, softened appreciably, making shorter-duration instruments particularly attractive to investors seeking safety and liquidity amid global volatility. Domestic investor participation remained firm, with balanced allocations between short and medium-duration funds, though foreign portfolio flows into Indian debt stayed tentative. A major influence on investor behaviour was the evolving global monetary policy landscape, led by the US Federal Reserve’s decision to pause additional rate cuts and signal only a modest reduction in the coming year, rather than the previously anticipated 50 bps easing. This decision kept US Treasury yields elevated, with the 10-year note remaining in a 4.26–4.5% range. The narrowing of the yield spread between US Treasuries and Indian government bonds to well below long-term averages made Indian debt comparatively less attractive to foreign investors on a risk-adjusted basis. As a result, foreign portfolio flows into Indian bonds, which had modestly rebounded in June after earlier outflows driven by trade tensions and global market volatility, remained subdued and highly sensitive to any shifts in US rate expectations. Geopolitical factors also played a significant role in shaping sentiment. Ongoing tensions in the Middle East, especially the escalation in the Iran-Israel conflict, fuelled spikes in crude oil prices and created uncertainty about the stability of global energy supplies. Although domestic inflation remained generally under control in July, markets remained vigilant for any signs of imported inflation pressures and the potential impact on the RBI’s policy stance. This caution kept longer-tenor yields from falling meaningfully despite comfortable liquidity conditions. Additionally, the aftershocks of the Russia-Ukraine war continued to reverberate through global commodity and currency markets, reinforcing a backdrop of risk aversion among international investors. On the domestic front, the fiscal picture improved and offered a degree of reassurance to market participants. India’s fiscal deficit showed signs of narrowing, with policymakers emphasizing discipline and a clear trajectory toward reducing the government debt-to-GDP ratio over the medium term. This commitment was welcomed by credit rating agencies and investors alike, as it suggested that the supply of government securities could be more contained in the coming quarters, thereby supporting yields and anchoring inflation expectations. Even so, the positive impact of these structural improvements was partly offset by lingering global concerns, including downgrades in the US sovereign credit rating and mounting worries about the fiscal health of other large developed economies. Such developments contributed to volatility in global bond and currency markets, indirectly influencing India by raising the required risk premiums on emerging market debt. Domestic institutional investors focused on the front end and belly of the curve, capitalizing on the softer short-term rates and adequate liquidity. Meanwhile, foreign investors adopted a wait-and-watch approach, closely monitoring US Treasury movements, crude oil price trends, and evolving geopolitical risks before increasing their allocations. On the shorter end of the curve, the liquidity support from the RBI’s earlier measures meant that Treasury Bill yields and short-term commercial paper rates remained attractive relative to comparable instruments globally, drawing consistent demand. On the longer end, the combination of global uncertainties and the RBI’s neutral stance kept yields anchored within a narrow band but prevented a more pronounced rally. In the money market, borrowing costs were steady to mildly lower, reflecting the surplus system liquidity and absence of stress in short-term funding. The supportive environment allowed corporates to roll over maturing liabilities without significant pricing pressures, and investors seeking safety found sufficient high-quality paper to deploy funds. However, traders and asset managers remained alert to the potential for sudden repricing in the event of further oil price escalation or an unexpected shift in global rate policy. The Indian debt market in July 2025 was characterized by a delicate balance of supportive domestic trends and formidable external headwinds. While comfortable liquidity, improving fiscal metrics, and controlled domestic inflation provided a stabilizing backdrop, high US yields due to delayed Federal Reserve rate cuts, aggressive monetary tightening by developed economies, and geopolitical disruptions in the Middle East combined to create an atmosphere of caution. Market sentiment remained watchful as participants weighed the prospects of further global dislocations against India’s resilient macro fundamentals.