Fiscal Policy Emerges as Primary Driver for Indian Bond Yields in Early 2026
India's bond market is currently navigating a landscape where fiscal policy considerations are exerting more influence than monetary measures. As the first quarter of calendar year 2026 unfolds, bond yields are demonstrating resilience, primarily shaped by government borrowing patterns and budgetary expectations rather than central bank actions alone.
Budgetary Expectations and Yield Trajectory
The upcoming Union Budget stands as a significant catalyst for Indian bond yields, though financial analysts anticipate limited immediate volatility. According to a recent analysis by Radhika Rao, Executive Director and Senior Economist at DBS Bank, "INR bond yields remained firm into the new year, against the backdrop of low inflation, accommodative but cautious policy and actively managed liquidity." This firmness persists despite the Reserve Bank of India's interventions through open market operations and foreign exchange swaps in December.
State Borrowings and Institutional Constraints
Two primary factors underscore the dominance of fiscal policy in the current yield environment. First, state government borrowings have been concentrated in the first quarter, with plans to raise approximately ₹5 trillion—a quarterly record at the higher end of market expectations. This substantial borrowing follows scaled-back issuance in previous quarters aimed at preventing yield hardening.
Secondly, institutional investor participation faces multiple constraints. Bank replacement demand remains subdued, pension funds are showing only incremental interest while favoring equities, and insurance companies operate within regulatory limitations. These factors collectively limit absorption capacity beyond active central bank purchases.
Yield Range and Key Catalysts
With the 10-year government security yield hovering above 6.6%, market participants expect an upside bias within the 6.6–6.7% range in the near term. The Union Budget and the February RBI policy meeting are identified as crucial events that could influence this trajectory. Tushar Sharma, Co-Founder of Bondbay, notes, "On the domestic front, fiscal supply remains the dominant driver." The government's front-loaded borrowing program keeps markets sensitive to any perception of fiscal slippage.
Global Influences and Inflation Risks
International developments are creating additional pressures on Indian bond yields. Rising commodity prices, particularly industrial metals like copper and precious metals including gold and silver, pose upside risks to global inflation expectations. Harsimran Singh Sahni, Executive Vice President and Treasury Head at Anand Rathi Global Finance, observes, "Globally, over the last few months, yields have been slowly and steadily inching higher."
Elevated yields in developed markets such as the United States, Japan, and the United Kingdom generate spill-over effects for emerging market bonds, including India's. Sahni points to Japan's yield movement from 1.6% to 2.20% and US yields recently breaking above 4.20% as factors that could push global treasury yields slightly higher.
Fiscal Deficit and Market Expectations
Market sentiment remains closely tied to fiscal discipline indicators. Murthy Nagarajan, Head of Fixed Income at Tata Asset Management, explains, "If fiscal deficit is lower and net borrowing comes low, this should lead to a rally in bonds." Current market expectations project a fiscal deficit around ₹17 lakh crore with net market borrowing at ₹11.5 lakh crore, assuming fiscal consolidation at 4.2%.
Nagarajan further highlights that potential trade agreements with the European Union and United States could positively impact markets, while the absence of such deals combined with dollar debasement could increase current account deficits and commodity prices, adversely affecting inflation outlooks.
Monetary Policy Constraints and Outlook
While the RBI maintains an accommodative monetary stance, its ability to significantly influence yields appears constrained. The central bank continues active liquidity management but remains cautious about premature easing signals. Sharma adds, "This limits the downside for yields in the near term." Even with RBI support, sustained government borrowing without clear reduction in issuance pressure may keep yields elevated.
Although inflation currently remains manageable, any unexpected increases—particularly in food or energy sectors—could quickly alter rate expectations and repricing dynamics.
Disclaimer: This analysis is for educational purposes only. The views and recommendations expressed are those of individual analysts or broking firms. Investors are advised to consult certified experts before making investment decisions.
