India’s short-end bonds faced another bout of sell-off, with yields continuing to adjust up this week. Lack of fresh catalysts after RBI’s move to frontload rate cuts this month, stance change back to neutral, higher bar for further rate reductions and, more recently, its move to cancel daily as well as 14-day main variable rate repo auctions, have hurt appetite. Jump in oil prices following Israel’s attack on Iran also dented demand. Auction cancellations were perceived as a sign of authorities’ comfort with the current surplus in the system, despite upcoming seasonal tax outflows. Investors also questioned whether the next move would be to absorb excess liquidity to align overnight borrowing costs back to the policy rate (instead of below the repo). In the near-term, a potential dialling back in Israel-Iran tensions and resultant correction in oil prices might provide part relief to domestic bonds. Official commentary on the preference for lower borrowing costs will be necessary for INR bonds to resume their rally from current levels.
Moderation in export and import growth in May led to a narrower trade deficit of $21.8bn compared to $26.4bn in April. Exports fell -2.2% yoy from 9% in April, with imports also contracting 1.7% vs +19% in April. Electronics and chemical exports fared well, while key segments like petroleum, gems & jewellery and textiles moderated. Export growth to the US remained strong (Apr-May ~22% yoy), besides firm imports from China (Apr-May ~24% yoy), likely marking a continuation of frontloading of demand ahead of the July tariff announcements as well as rerouting of exports through the region to take advantage of the tariff differential. The outlook for the year is likely to be dictated by, a) tariff developments in early-July, b) progress on the India-US bilateral trade agreement. An early harvest deal is expected to be signed by early July; c) passage of frontloading of exports in the coming months; d) anecdotal signs of selected domestic industries facing a shortage of rare earth magnets in midst of US-China trade disputes, with India’s private and public sector seeking to ensure supplies from China on bilateral basis before current inventories dip in 3Q. A strong service trade surplus, meanwhile, continues to be a key counterbalance for the goods deficit, with Apr-May25 service surplus up 19% yoy. Overall, we expect 2Q25 (1QFY) current account deficit to stay benign, while maintaining our full-year FY26 baseline forecast at -0.7% of GDP, keeping external macro balances in a favourable shape.
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