Great start to FY2026 - Debt Outlook by Puneet Pal, Head Fixed Income, PGIM INDIA Mutual Fund

The bond market had a great start to FY2026 as yields came down across the curve as the Reserve Bank of India's (RBI) Monetary Policy Committee (MPC) not only reduced the policy repo rate but also changed the monetary policy stance to "accommodative "from "Neutral". The benchmark 10yr bond yield fell to a three-year low, ending the month at 6.36%. The yield curve steepened with the shorter segment yields falling more than the longer segment.

Apart from the rate action, RBI continued with liquidity infusion measures and conducting more Open Market Purchases. The RBI has so far conducted/announced over INR 5 lakh cr of Open Market Operations (OMO) purchases (including the announced OMO purchase of INR 1.25 lakh cr for May).

In addition to the OMO purchases, the RBI has also conducted USD/INR buy/sell swaps to the tune of INR 2.18 lakh cr. Thus, the RBI's proactive stance towards liquidity management and its liquidity infusion has resulted in the banking system's liquidity turning into a surplus of almost INR 1.50 lakh cr, from a deficit of INR 3.10 lakh cr in January 2025.

On the flip side, the RBI continues to run a negative USD forward position of almost USD 88 bn as of Feb 2025 end, and these liquidity measures will also balance the outflows associated with the maturity of these forward positions. In any case, the message from RBI is dovish both on liquidity and rates and the market is expecting further rate cuts to the tune of 50-75bps along with sustained liquidity surplus to the extent of 1% of Net Demand and Time Liabilities (NDTL).

The month started with a rebound in the Purchasing Managers Index (PMI) numbers with the composite PMI coming in at 59.5 compared to 58.80 of the previous month. Industrial production slowed to 2.90% with softer print across sectors, though there was also the leap year impact of one less working day. Consumer Price Index (CPI) inflation eased more than expected to 3.34%, (consensus 3.50%), slowing for the fifth consecutive month and the lowest since September 2019.

Food inflation also came in benign at 2.90% while the core inflation came in at 4%, marginally lower than 4.10% from March. Though core CPI inflation has picked up from its low of 3.10%, the internals (the major composition of core inflation) remain benign. Further, the Indian Meteorological Department's (IMD) above normal monsoon prediction offers more comfort on food inflation, with softer crude oil prices also having a benign impact on global food prices.

Thus, inflation trajectory looks to be in consonance with the RBI's forecast of 4% for FY26. Wholesale Price Index (WPI) inflation was also lower than expectations, coming in at 2.05% (consensus: 2.50%). Food inflation moderated to 4.40%, lowest since September 2024 while core inflation edged higher to a 25-month high of 1.60%. The trade deficit for March 2025 increased to USD22bn with pick-up in oil and core imports. For FY25 the overall goods trade deficit widened to USD 287bn from USD 245bn in FY24 while the services surplus was higher at USD 189bn in FY25.

The minutes of the MPC policy were dovish as the MPC noted that inflation concerns have abated and that there was a need to support growth in an uncertain global environment. In fact, Dr. Kumar advocated a 50bps rate cut. Overall, the minutes of the MPC meeting reiterated the need to support growth while expressing confidence that the inflation trajectory will align durably to the RBI's 4% inflation target.

Money Market yields also came down post the financial year end, supported by surplus liquidity. FPI flows in debt turned negative with almost USD 3bn of outflows even though yields continue to drift lower across the curve.

Globally, markets were volatile with the announcement of US trade tariffs and the subsequent postponement of the same. US bond yields also suffered from bouts of volatility as the benchmark US 10yr bond yield touched a high of 4.49% during the month though it ended the month at 4.16%, down 9 bps from previous months closing.

Going ahead, we expect a further 50 bps of rate cut by the MPC though the neighborhood geopolitics needs to be watched. As expected, both the banking system and the durable liquidity has turned surplus and the overnight lending rates are trading between the Repo rate and the Standing Deposit Facility (SDF) rate. We expect the yield curve to remain steep and expect the belly of the curve (5yr-10yr) to outperform going ahead.

Source : Equity Bulls

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DebtOutlook FY2026 PGIMIndiaMutualFund