Domestic bond yields were lower across the curve on a correction in oil prices and supportive RBI commentary in the past week. Benchmark 10Y bond yields broke out of their range to ease below 6.8% to Mar26 lows, accompanied by a modest retreat in short-end rates. Lower oil prices have led to a reassessment in associated macroeconomic risks (India: Terms of trade pressure eases, constructive BOP dynamics). Rate hike expectations were also scaled back after dovish cues from the June MPC minutes were reinforced by recent comments from the RBI Governor where he downplayed the urgency to tighten policy levers, saying that rate hike talks were premature and any such intention would have been pre-empted by a shift to a tightening stance in June. We have revised our rate call to an extended pause this year. Onshore liquidity has been tight on seasonal drivers, though is expected to benefit from incoming non-resident flows and offshore borrowings under the special schemes. A sharp pick up in foreign inflows into debt in June ($5.6bn; 75% of which was under Debt-FAR category), and bond buyback (INR74bn accepted vs INR300bn made available) added to the positive momentum in bonds. Any delay/disappointment on the inclusion into the Bloomberg’s global index might lead to a modest retracement in yields in the near-term, besides a sharp uptick in developed market yields.
Amid a sharp rise in oil prices in Apr-May26, the central government's fiscal deficit reached 10% of the full-year FY27 budget target by May, compared to 0.8% in the corresponding period a year earlier. The deterioration reflected front-loaded expenditure, driven primarily by a 47% yoy increase in food and fertiliser subsidies, alongside on-track capital expenditure (up 13% ytd). On the revenue end, net tax receipts benefited from higher direct (income and corporate tax) and indirect (customs) collections, apart from contribution from higher RBI dividends, though other non-tax sources declined. While energy prices have subsidised into June, further spending rationalisation will be necessary to keep full-year math close to FY27 target. We expect a modest slippage this year, lower than previous indicative ~40-50bp. USDINR eased towards mid-94 handle, with further downside offset by a moderation in the RBI’s forward book (NDF maturities) and a firm dollar. In the near-term, rupee stands to gain further on BOP-accretive flows and lower commodity prices. Further ahead, we expect the authorities to resume absorbing incremental US dollar inflows to rebuild foreign exchange reserves, paving the way for a gradual resumption of upside in USD/INR (FX Quarterly 2Q 26: Less De-Dollarisation, More Polarisation).
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