Union Budget 2026 Proposes Record ₹17.2 Lakh Crore Market Borrowing
The Indian government has announced a record gross market borrowing of ₹17.2 lakh crore for the upcoming fiscal year in the Union Budget 2026. This substantial figure has surpassed market expectations and immediately triggered significant movements in the bond market. On February 2nd, the announcement propelled the yield on India's benchmark 10-year government security (G-Sec) to a one-year high, creating immediate concerns across financial markets.
Bond Yields Remain Elevated Despite Rate Cuts
Although bond yields have moderated somewhat in subsequent trading sessions, they continue to hover at an eleven-month high of 6.7%. This elevated level persists despite the Reserve Bank of India implementing cumulative rate cuts totaling 125 basis points in the repo rate over recent periods. The sustained high yields present particular challenges for financial institutions, especially those with significant exposure to government securities.
Impact on Public Sector Banks' Treasury Portfolios
The higher bond yields could potentially exert substantial pressure on banks' treasury portfolios, with state-owned public sector banks facing particular vulnerability due to their traditionally large holdings of government securities. However, financial analysts suggest the overall impact might be more limited than initially feared. They point to stronger core credit growth and improving net interest margins as factors that could offset treasury volatility over the full fiscal year.
"Public sector banks are structurally better positioned today to manage bond yield volatility compared to previous cycles," noted market observers. This improved resilience stems from strengthened balance sheets and more sophisticated treasury positioning developed over recent years.
Expert Analysis: Near-Term Treasury Impact
Anil Rego, Founder and Fund Manager at Right Horizons PMS, provided detailed insights into the potential near-term consequences. "The higher-than-expected FY27 gross borrowing program is likely to maintain firm government bond yields in the near term," Rego explained. "This situation raises the risk of mark-to-market pressure on banks' treasury portfolios."
With yields projected to gradually increase throughout the year amid elevated borrowing requirements and reduced probability of further rate cuts, valuation losses on held-for-trading and available-for-sale portfolios could become more pronounced. This effect will be particularly visible for institutions maintaining larger proportions of government securities outside the held-to-maturity category.
Uneven Impact Across Public Sector Banks
The impact on public sector banks will be highly uneven according to treasury positioning. Banks that previously established substantial held-to-maturity cushions may experience relative insulation, since securities in this category are not subject to daily mark-to-market valuation changes. Conversely, institutions that increased available-for-sale exposure during periods of softer yields could see quarterly treasury volatility escalate if the 10-year yield trends toward higher levels throughout FY27.
Rego emphasized that "the stress is more likely to be earnings-timing related rather than structural." While stronger core credit growth and improving margins can offset treasury swings over the full year, reported profits in individual quarters may appear more volatile if bond yields remain elevated.
Limited Spillover to Net Interest Margins
Firming bond yields are more likely to affect public sector banks primarily through treasury performance rather than immediate core banking metrics. Rising yields typically translate into mark-to-market pressure on available-for-sale and trading portfolios, creating volatility in treasury income. This becomes particularly relevant in an environment where yields are expected to drift higher alongside elevated government borrowing and reduced likelihood of policy rate cuts.
The transmission to net interest margins is slower and more nuanced. On the asset side, a substantial portion of public sector bank loan books is linked to floating benchmarks, allowing lending rates to reprice over time. On the liability side, deposit costs adjust with a lag, though competitive pressures in mobilizing term deposits may keep funding costs somewhat sticky. Consequently, while sustained high yields can gradually compress margins if deposit repricing outpaces loan repricing, the near-term impact on net interest margins is typically limited.
Market Correction: Sentiment Versus Fundamentals
Public sector banking stocks have corrected sharply following the spike in bond yields. From a valuation perspective, this correction appears driven more by sentiment surrounding rising bond yields than by moderation in underlying earnings. The yield spike has heightened concerns about mark-to-market pressures on treasury portfolios and the possibility of softer bond gains, which tend to weigh disproportionately on public sector banks given their relatively higher exposure to government securities.
Nevertheless, the earnings impact is likely to be more about quarterly volatility than structural impairment of profitability. Core operating trends for public sector banks, including credit growth, improving asset quality, and stronger provision buffers built over recent years, provide substantial cushion against treasury-led fluctuations.
Improved Structural Positioning
Public sector banks are structurally better positioned today to handle bond yield volatility than in earlier cycles, largely because balance sheets and treasury positioning have strengthened over the past few years. Capital adequacy levels across most large public-sector lenders are materially higher than in previous rate upcycles, providing thicker buffers to absorb mark-to-market swings without materially constraining lending or growth plans.
Additionally, many public sector banks have consciously built larger held-to-maturity portfolios, which shield meaningful portions of their government bond holdings from daily valuation changes, thereby reducing earnings volatility from rising yields. Compared with earlier periods when treasury books were used more aggressively to boost profits, banks today follow tighter duration management and more conservative classification between held-to-maturity and available-for-sale buckets.
Long-Term Investment Perspective
Beyond immediate volatility from higher bond yields, the broader investment case for public sector banks still hinges more on core operating trends than treasury movements. Elevated government borrowing is likely to keep yields firm and reduce scope for bond-driven gains, but this primarily affects treasury income rather than the fundamental earnings engine of these banks.
Credit growth and operating performance continue to be the key cushions. Public sector banks have been experiencing healthier loan growth across retail, MSME, and corporate segments, supported by stronger balance sheets and lower legacy stress. Asset quality has improved meaningfully over recent years, reducing provisioning drag and allowing greater shares of operating profit to flow through to the bottom line.
Even if net interest margins face some gradual pressure from higher deposit costs, the impact is typically spread over time rather than abrupt. In this context, while higher borrowing and firm yields may cap treasury upside, steady credit expansion, better recoveries, and disciplined cost control can still support overall profitability through FY27, making the earnings story more resilient than bond-market moves alone might suggest.
