Rupee and G-sec yields hinge on RBI credibility

India’s currency and bond markets are entering a delicate phase as the Reserve Bank of India (RBI) faces the dual challenge of defending the rupee while simultaneously maintaining orderly government bond yields. The Indian Rupee (INR) has depreciated to near 84.3 per U.S. Dollar (USD), reflecting persistent twin deficits, high crude imports, and moderate capital outflows.

Concurrently, the 10-year Government Security (G-sec) yield hovers around 7.38%, having advanced 20 basis points (bps) in the past month, a move that highlights investor sensitivity to domestic fiscal spending trajectories and the monetary stance. RBI interventions, executed both in the spot Foreign Exchange (FX) market and through Open Market Operations (OMOs), are currently the primary stabilizing mechanism. This reflects a credible policy anchor but also exposes the market to near-term volatility risk should external pressures intensify.

Underlying macro fundamentals provide crucial context for the RBI’s actions. GDP growth slowed slightly to 5.6% year-on-year (y/y) in the second quarter of Fiscal Year (FY) 2025, while retail inflation averaged 5.1% y/y, marginally above the midpoint of the RBI’s mandated 4±2% target. This persistent inflation above the comfort zone constrains room for any rate cuts.

High fiscal deficit expectations, projected near 6.2% of GDP for FY2025, combined with a heavy schedule of upcoming bond issuances, further pressure G-sec yields. The RBI’s calibrated interventions—utilizing FX reserves, which stand near USD 600 billion, and managing bond-market liquidity—aim to prevent disorderly adjustments, maintain investor confidence, and ensure that financing costs for sovereign and corporate borrowers remain manageable.

The transmission mechanism of the RBI’s stability efforts extends across both domestic and external investment channels. By stabilizing the rupee, India mitigates imported inflation risks and maintains predictable import costs, thereby supporting real consumption. Bond-market stability, in turn, facilitates corporate borrowing and critical infrastructure financing, including government-backed Public-Private Partnerships (PPPs).

Equity markets, particularly the NSE Nifty 50 (NSEI) financials and infrastructure segments, have absorbed these signals, with net Foreign Institutional Investor (FII) inflows turning positive over the last three weeks, a data point which suggests that RBI credibility remains an effective anchor.

Risks remain significant, particularly from external shocks. Persistent global capital outflows or a severe commodity price shock could force more aggressive interventions, potentially straining India’s FX reserves. Furthermore, high leverage in both the household and corporate sectors implies that even modest rate adjustments or sustained high yields could adversely affect debt-servicing capacity.

Forward-looking indicators to monitor include M3 money supply growth, FX reserve movements, and the shape of the yield curve, all of which will determine whether India can successfully navigate external headwinds while preserving moderate domestic growth. If the current stability operation proves successful, the INR is expected to stabilize near 83–84/USD over the next six months, with 10-year G-sec yields trending toward 7.2–7.3%.