Topic 2: DEBT

Indian debt markets in December 2025 navigated a complex mix of supportive domestic policy actions and constraining external and supply-side pressures, resulting in a month of modest yield softening rather than a sustained rally. Government bond yields eased meaningfully through the middle of the month as the Reserve Bank of India stepped up liquidity support, but those gains were partly retraced toward month-end amid heavy borrowing supply, currency weakness and global rate headwinds. The benchmark 10-year government security yield began December near 6.85%, declined steadily as RBI interventions took effect, touched a low of around 6.54% on December 24, and then stabilized in the 6.60–6.61% range by the end of the month.
Despite the late-month uptick, yields finished December lower than they began, translating into positive returns for duration-sensitive bond funds, although the extent of gains remained capped. The RBI played a central role in shaping market dynamics during the month, delivering a 25 basis point repo rate cut to 5.25% and complementing it with large-scale liquidity measures, including open market operations (OMOs) totalling roughly ₹2 trillion in December alone and cumulative purchases exceeding ₹3 trillion for FY26, the highest on record. These bond purchases, focused largely on the 6–7 year segment such as the widely traded 6.33% 2035 bond, significantly eased systemic liquidity conditions and compressed term premiums, offering relief to a market that had been grappling with cash shortages stemming from currency in circulation outflows and RBI forex interventions. Additional support came from USD 5 billion buy/sell swaps, which injected durable rupee liquidity of ₹2–3 trillion and helped anchor overnight rates closer to the repo rate. At the shorter end of the curve, one-year government bond yields remained relatively stable in the 5.84–5.90% range, while overnight index swap (OIS) rates between 5.46% and 5.76% early in the month reflected intermittent liquidity tightness that gradually eased as RBI measures filtered through the system. Even with these actions, however, liquidity conditions were not unambiguously comfortable: surplus liquidity declined to around ₹3.3 trillion at times, and RBI infusions had to counter an estimated ₹1.5–2 trillion drain from strong credit demand and ongoing forex operations.
On the fiscal and supply side, persistent pressures limited the scope for a deeper rally in yields. The government’s borrowing program remained heavy, with record state development loan (SDL) issuances in the December quarter and a particularly large supply pipeline for Q4, which weighed on demand-supply dynamics even as OMOs absorbed some of the pressure. Concerns around fiscal slippage also lingered, driven by a combination of tax cuts, moderation in GST collections, and a high central government debt burden—estimated at over 60% of total market borrowings—which kept investors cautious about aggressively extending duration. Banks’ holdings of government securities fell to around 35.3% year-on-year, indicating some balance-sheet constraints, while pension funds showed signs of reallocating toward equities amid strong stock market performance, reducing a traditionally stable source of long-term demand.
Currency movements further complicated the picture, as the rupee depreciated sharply by nearly 2% during December, slipping to around 90.8 per US dollar amid heightened global risk aversion, US tariff announcements of up to 50% on certain trade fronts, and a firm dollar environment. This depreciation raised concerns about imported inflation and triggered bouts of foreign portfolio investor outflows from the debt market, contributing to intermittent yield hardening despite domestic easing. Inflation data at home remained benign, supported by falling food prices, favourable base effects and a decline of about 4.4% in global crude oil prices, but global inflation persistence and the risk of currency pass-through prevented markets from pricing in an aggressive or front-loaded easing cycle. Global factors continued to exert influence throughout the month, with US Treasury yields holding above 4%, limiting the relative attractiveness of Indian debt, while ongoing tightening bias in parts of Europe, China’s deflationary signals, and broader geopolitical uncertainties added to volatility. Strong domestic macro data also played a nuanced role: Q2 GDP growth of about 8.2% year-on-year led to upward revisions of FY26 growth expectations toward 7.2%, reinforcing confidence in the economy but simultaneously tempering expectations of sharp rate cuts and anchoring longer-term yields. As a result, while the RBI’s dovish stance and liquidity operations successfully stabilized the bond market and delivered moderate gains, especially in the belly of the curve, external headwinds, fiscal supply pressures and currency risks ensured that December 2025 remained a month of measured easing rather than a decisive bond rally, leaving the market balanced between supportive policy and persistent structural constraints heading into 2026.