Gsec yield curve may flatten in FY27

The government bond yield curve is likely to flatten in the financial year 2027 (FY27) as the Reserve Bank of India (RBI) is expected to ease supply pressure in the ultra-long segment.

Illustration: Dominic Xavier/Rediff

In FY26 so far, reduced investments by insurance companies and pension funds pushed up yields on ultra-long tenor securities, steepening the curve.

A recalibration of issuance, however, could help normalise yields at the long end in the coming year, experts said.

“The upward pressure on ultra-long bond yields reflects a combination of higher duration supply and weak investor demand, led primarily by insurance companies and pension funds.

“For insurers, slower inflows and post-tax changes that reduced demand for guaranteed products have weighed on investments.

“In the case of pension funds, although AUM growth has been robust, a larger share is being channelled into equities following the enhancement of equity investment caps,” said Gaura Sen Gupta, chief economist at IDFC First Bank.

In FY27, the yield curve may get some relief as long-term demand is expected to improve, experts said.

“We have observed that insurance companies have been reducing their investments in government securities, contributing to higher long-end yields.

“A similar trend is visible among provident funds. PFs have been permitted to allocate more to equities, and data clearly reflects this shift.

“Additionally, more PFs are surrendering to EPFO, reducing the overall size of PF investments,” said a senior executive at a primary dealership.

The yield curve may flatten due to normalisation in bond issuance after one-off regulatory changes for the National Pension System (NPS) and banks under relaxed liquidity coverage ratio (LCR) norms, higher investments by gratuity funds and possibly provident funds following labour law changes, and the likely inclusion of Indian bonds in the Bloomberg Global Aggregate Index, which could attract over $20 billion of passive inflows over a year.

“FY27 could see some respite for the slope of the G-Sec curve, led by normalisation of long-end demand following one-off regulatory adjustments by NPS and banks amid easier LCR norms, higher allocation from gratuity pools and possibly PFs, and potential inclusion in the Bloomberg Global Aggregate Index,” Emkay Global said in a note.

The RBI has stepped up liquidity support, announcing an additional Rs 2 trillion of open market operation (OMO) purchases and a $10 billion dollar/rupee buy-sell swap to be conducted between end-December and January 2026.

The scale of durable liquidity infusion was significantly higher than expectations, reflecting the RBI’s response to persistent liquidity drain from foreign exchange intervention and stress in bond and currency markets.

Following the announcement, government bond yields posted their strongest rally since April, falling by 9 basis points.

This was the sharpest rally since April 2, when yields declined by 10 bps.

System liquidity slipped into deficit after advance tax outflows on December 15.

Earlier liquidity measures, including Rs 1 trillion of OMOs and a $5 billion buy-sell swap announced in mid-December, were largely offset by tax-related drains.

Core liquidity (banking system liquidity plus government cash balances) stood at Rs 3.2 trillion on December 15 and is estimated to have risen to about Rs 3.7 trillion after the Rs 50,000 crore OMO purchase with a December 19 value date.

Government cash balances, which were Rs 1.9 trillion on December 15, are estimated to have increased to about Rs 3.9 trillion following advance tax and GST collections.

Elevated government cash balances suggest system liquidity could turn surplus towards the end of December as government spending accelerates.

So far in FY26 (up to December 19), the RBI has injected Rs 3.7 trillion through net OMO purchases and Rs 2.6 trillion via CRR cuts, in addition to conducting a $5 billion buy-sell swap in December.

The swap, however, is primarily aimed at extending the maturity of the RBI’s forward book rather than providing durable liquidity.

Despite these measures, RBI’s net dollar sales in the spot and forward markets drained around Rs 3.3 trillion of liquidity in FY26 so far (up to December 15).

Currency leakage, driven by recovery in rural demand, has added another drag of about Rs 1.9 trillion.

On balance, RBI actions lifted core liquidity to around Rs 3.7 trillion by December 2025, from Rs 2.1 trillion at end-March 2025.