Indian bonds took a breather after a tough August, trimming losses witnessed in the past fortnight. Benchmark yields had risen to five-month highs in late-August, before retreating modestly this week. Markets were encouraged by constructive commentary from officials, as indications were that the FY26 deficit target will be met, thereby keeping the 2H25 borrowing program unchanged (at INR 6.8trn in Oct25-Mar26), despite slower revenue growth and modest miss due to GST cuts. The central bank was also reportedly consulting domestic players, ahead of tabling the borrowing schedule for 2HFY in end-September. Expectations are that the proportion of long-end maturities will be reduced, and supply will shift towards short-to-belly duration to accommodate structural and regulatory changes impacting demand by domestic investors. That said, in absence of steps to support markets, either through bond purchases in the secondary market, dovish guidance or moves to trim supply, the scope for one-sided rally in benchmark bonds in the near-term remains limited.
Rupee has been under pressure. The INR slipped to a fresh low on Thursday below 88.40/USD, emerging as a regional underperformer (-3.2% YTD), but helping to partly offset the impact of steep tariffs. On real effective exchange rate basis, the currency is likely slightly undervalued compared to trading partners (Jun, Jul25 was 99.7 and 100.1 respectively). Separately, the cabinet is reportedly mulling over a support package for exporters to offset the impact of the US tariffs, including collateral-free and cheap credit, dipping into the INR 22.5bn tranche demarcated in the budget for export promotion. August inflation, due on Friday, is likely to tick up to 2.1% yoy after the trough at 1.6% yoy month before. Food costs are up on sequential basis, impacted by instances of a surge in monsoon in few areas of the country. Pulses and cereals, meanwhile, continue to decelerate. Fuel related segments will reflect the yoy rise in non-subsidized LPG, apart from which imported fuel price pressures remain benign. The central bank will weigh the strong GDP print for 1QFY26 against the soft inflation trend, likely leaning towards a pause at the next review. Fiscal support via GST rate rationalization as well as direct tax relief will be demand-accretive in second half of the year. Policy guidance will be important considering the recent jump in long-term bond yields and widening spreads vs SDLs.
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