Bond yields flattening: Bank treasury officials anticipate that the government bond yield curve will continue to flatten as long-term interest rates decrease due to robust demand for longer-dated securities. The spread between the Reserve Bank of India policy rate and benchmark bond yield has narrowed to 50 basis points, marking the flattest curve in nine months.

India's 10-year bond yield nearly touched 7 per cent on Monday, while the repo rate stands at 6.5 per cent. Analysts predict that the 10-year benchmark bond yield could potentially drop to 6.50 per cent in the next six months, possibly even falling below the repo rate prior to any rate adjustments.

Foreign investor influx

The decline in yields for bonds with maturities exceeding 10 years is attributed to strong demand from both domestic and international investors, particularly ahead of India's inclusion in JPMorgan's index. Foreign investors have poured in over Rs 80,000 crore ($9.68 billion) in government debt since the announcement of India's inclusion on September 22.

On the other hand, short-term rates have remained elevated due to tight liquidity conditions and a cautious stance from the central bank, which has indicated that easing will only be considered when inflation stabilises close to the 4 per cent target. This imbalance in liquidity, combined with favourable demand-supply dynamics for longer-term bonds, has contributed to the flattening of the yield curve.

Yield intervention concerns

However, some experts caution that this trend may not persist indefinitely, as the central bank may intervene to prevent the 10-year yield from dropping below 6.60-6.65 per cent. As yields decrease, local banks may offload excess government bonds they are holding, as they are currently exceeding the required statutory liquidity ratio of 18 per cent of their deposit base.

​(With Reuters Inputs)