India bond market in 2025: inflation cools, yields split

Global index inclusion puts India bonds in focus

India’s ongoing bond inclusions in global indices, including the FTSE WGBI, have been cited as evidence that the domestic fixed income market has matured and become fully investible. The inclusion theme has kept global investors engaged with India’s rates cycle and market access. At the same time, the flow picture has not been one-way, as bouts of geopolitical tension and broader global uncertainty have triggered temporary pullbacks in foreign inflows. Even so, the narrative around structural demand has remained tied to index inclusion and the depth of the onshore government bond market. Market participants have also tracked the interaction between passive flows and India’s domestic demand for bonds. Alongside inclusion, discussions have centred on macro conditions such as inflation, fiscal consolidation, and monetary policy.

Inflation downshift becomes a key driver

One of the most important macro drivers highlighted has been the decline in Indian inflation from a peak of 6.2% year-on-year in October 2024. The disinflation trend continued into April 2025, when headline CPI fell to 3.2% year-on-year, described as the lowest level since August 2019. Lower food prices were flagged as a key factor over several months, supported by a strong harvest. Later readings were even softer in parts of 2025, with July CPI reported at 1.55% to 1.6% and June CPI at 2.1%. Another data point cited CPI inflation at an eight-year low of 1.54% in September, averaging around 1.7% for the quarter. The sequence of readings has shaped expectations for how long India can stay in a lower inflation regime.

RBI moves from cuts to a more cautious pause

With inflation returning to the mid-point of the RBI’s 2-6% target band, the central bank delivered its first rate cut since 2020 in February, followed by further cuts in April and June. More recently, the policy message has appeared less dovish even as inflation printed well below 4%. After the August MPC meeting, the repo rate was held steady at 5.50% and the RBI maintained a ‘neutral’ stance. In commentary attributed to Puneet Pal of PGIM India Mutual Fund, the RBI’s October 1 MPC meeting was described as dovish in tone while keeping policy rates unchanged. The central bank also lowered its FY26 inflation forecast to 2.6% from 3.7% in June and revised GDP growth upward to 6.8% from 6.5%.

What 10-year yields are signalling

India’s 10-year government bond yield has moved in both directions across the period described. At one point, the 10-year yield edged down to around 7%, retreating from multi-year highs on renewed buying interest as concerns over tighter policy softened. Traders linked improved risk appetite to expectations that the RBI may hold rates steady, reducing earlier speculation of aggressive tightening. A separate move saw the 10-year yield ease to just below 7% after reaching over a one-month high, as softer crude prices eased inflation concerns. Yet in another phase, the bond market reaction to low inflation was described as “anything but dovish”, with the 10-year yield edging higher to around 6.39% after the August MPC and briefly touching 6.492% on August 12. Yields were said to be holding in the 6.45-6.50% range, with the benchmark closing at 6.49%, the highest since early April.

Auction supply and near-term positioning

Supply dynamics also featured in market moves. Early selling pressure was triggered by the unexpected continuation of a 340-billion-rupee government bond auction. That pressure later eased as participants reassessed the interest rate outlook. At one point, markets were focused on the RBI policy decision scheduled for April 8, reflecting how event risk can shift positioning quickly. These episodes show how the market can shift from macro-led trading to auction and liquidity-led trading in short periods. They also highlight why investors closely watch both headline inflation and operational signals such as auction calendars.

Foreign inflows: $18 billion in, but below projections

Foreign institutional investor participation has risen since index-related milestones, but not to the levels many projections assumed. Since the initial JP Morgan inclusion in June 2024, FIIs were reported to have brought in approximately $18 billion into the domestic bond market. This was described as significantly lower than projected inflows of $10-$10 billion. The core reason cited for sluggish inflows is a 20-year low interest rate differential between India and the US, which makes hedged rupee bond investments unattractive. The flow gap has become an important part of the market debate because it affects both demand for duration and currency dynamics. The article also notes that subdued foreign inflows could exert downward pressure on the Indian rupee, raising import costs and potentially contributing to inflation.

Curve behaviour and the yield-repo spread widens

Even as inflation fell sharply, the bond market was described as pricing caution through a wider yield-repo spread. The gap between the 10-year bond yield and the repo rate was cited as nearing 100 basis points and described as the widest in 2025. This widening was presented as a sign that investors expect the RBI to tread cautiously and avoid rushing into further rate cuts. In the first two weeks of August, yields were reported to have hardened by 17 basis points, driven mainly by concerns over fiscal pressures and weak investor demand. The market tone, in this framing, is less about near-term inflation prints and more about forward inflation projections and policy stance.

Analyst views and yield targets differ

Views on where yields go next vary across reports referenced. Puneet Pal said the market is beginning to accept that the rate-cutting cycle is near its end, though there may still be room for one more cut. He also expected the 10-year benchmark to trade in a 6.30% to 6.70% range over the next couple of months, and flagged State Development Loans (SDLs) as potential outperformers due to relatively attractive spreads and lower near-term supply. A Bandhan Bank analyst report said the 10-year benchmark IGB yield, around 6.25%, is expected to soften to 6.00% over the next 3-6 months. Jefferies linked lower inflation and policy flexibility to a 50 basis points reduction in policy rates, and anticipated further cuts of 75 basis points through 2025.

Key numbers snapshot

Market impact: what changes for investors and the rupee

The push and pull between disinflation and higher yields matters for pricing across credit markets because the 10-year benchmark is used as a reference for corporate borrowing costs. The widening yield-repo spread near 100 basis points suggests the market is demanding more term premium than the policy stance alone would imply. At the same time, index inclusion provides a structural pillar, even if actual FII inflows have lagged earlier estimates. The reported 20-year low India-US rate differential explains why hedged foreign participation can remain constrained despite a strong domestic disinflation story. The article also flags that weaker inflows could pressure the rupee, with possible second-round effects through costlier imports.

Why the story matters now

The current phase combines unusually low inflation prints with a bond market that is not uniformly pricing aggressive easing. RBI projections that inflation could climb toward the end of FY26 were cited as one reason markets were not pricing an October rate cut, despite CPI falling below the lower bound of the 2-6% target band in July. This divergence between spot inflation and market pricing is also visible in the persistent term premium and the wider yield-repo spread. On the structural side, bond index inclusions, fiscal consolidation, and domestic demand were presented as supports for market evolution, even as geopolitical risks can cause intermittent outflows.

Conclusion

India’s government bond market is being shaped by three forces: sharp disinflation, a policy cycle that has moved from cuts to a more cautious hold, and index-driven global attention that has not yet translated into projected foreign inflow volumes. In the near term, traders remain sensitive to RBI policy dates, inflation projections, crude price moves, and auction supply. The next major signposts in this story are policy decisions and how inflation expectations evolve into FY26, as reflected in RBI forecasts and bond market pricing.