Mumbai: India’s bond market is beginning to price in possible RBI rate hikes later this year after Friday’s fuel price increase renewed concerns over inflation, pushing government bond yields higher and reviving debate over whether the RBI may eventually need to raise rates.
On Friday, the benchmark 10-year government bond yield climbed 4 basis points (bps) to 7.06% after state-run oil marketing companies raised petrol and diesel prices by about ₹3 per litre. The yield had already risen around 10 bps since last week to close at 7.02% on Thursday, according to Bloomberg data. A hundred basis points equals 1%.
Market participants and economists said the rise in yields reflects growing concerns that higher oil prices could raise inflation and weaken the rupee, although they remain divided on whether the Reserve Bank of India would actually raise the repo rate.
To be sure, government bond yields have remained elevated despite the RBI having cumulatively cut the repo rate by 125 bps from February to December 2025. During this monetary policy easing cycle, yield on the 10-year government bond fell by only 8 bps.
Hike vs no hike
The debate over a repo rate hike comes as the RBI prepares to hold pre-policy consultation meetings with stakeholders from 20 May ahead of the monetary policy review on 5 June, three people aware of the matter said.
Some economists are expected to argue that the RBI should begin preparing markets for rate hikes, with a section advocating cumulative tightening of as much as 50 basis points in the second half of 2026 to anchor inflation expectations and support the rupee.
“It is inevitable that rates will have to be raised by at least 50 basis points this year,” an official aware of the development said.
HSBC, in a report dated 11 May, forecast two repo rate hikes over October-December and January-March quarters, taking the repo rate to 5.75% from the current 5.25%.
The hikes are based on projections that inflation will rise to 6% or higher for two to three quarters between September 2026 and September 2027, led by higher oil prices and the impact of rising temperatures in the El Niño, the report said.
“We expect the brunt of the shock to be felt by the informal sector—rural households and small firms—marking a change in India’s drivers of growth,” it said.
Others expect the RBI to remain on pause despite rising inflation risks. “The increase in fuel prices is likely to increase inflation by close to 20 bps through direct impact. The actual impact would be higher as higher fuel costs feed into prices of other items as well,” Sakshi Gupta, principal economist at HDFC Bank said.
However, Gupta believes that April inflation at 3.5% gives the RBI sufficient headroom before inflation breaches its upper tolerance band of 6%. In its April policy, the RBI had projected inflation for Q1FY27 at 4%, Q2 at 4.4%, Q3 at 5.2% and Q4 at 4.7%.
“We expect no change in the policy rate in CY2026 for now,” Gupta said, adding that the RBI is likely to remain cautious of both the impact on inflation and growth from the energy shock.
Radhika Rao, senior economist and executive director at DBS Bank, also does not expect an immediate rate hike. “Inflation risks remain muted for now, although rising pump fuel prices and poor weather could exert both first- and second-round inflationary pressures,” Rao said in a report on 13 May.
Gaura Sengupta, chief economist at IDFC FIRST Bank, also expects the RBI to look through the supply-side shock despite upside risks to inflation.
“Fiscal policy is better suited to deal with supply disruptions rather than monetary policy, the latter works via the demand channel… To limit downside risk to growth, we expect monetary policy to stay on pause,” she said.
Other measures expected from RBI
Some market participants also expect the RBI to consider measures beyond rate hikes to support the rupee, including steps related to foreign currency non-resident (FCNR) deposits and outward remittance rules, which could temporarily ease bond yields.
“While inflation and rupee pressures are building, the government’s recent push for austerity-like measures could open the door for a liability-raising programme such as FCNR deposits or quasi sovereign bond issuances,” Rajeev Pawar, treasury head at Ujjivan Small Finance Bank said.
“If the RBI backs such a programme with swap support, it could attract $30-50 billion in inflows, inject durable liquidity into the banking system and, in turn, support the bond market by easing yields,” Pawar said, adding that he expects the 10-year government bond yield to hover around 6.90-7.15% at least until the monetary policy announcement.