India’s Bond Market: Navigating Uncertainty Amid Tariffs, GST Rejigs, and RBI’s Stance

India’s bond markets have entered a turbulent phase in recent months. Yields have climbed sharply, reflecting investor unease, while prices have correspondingly fallen. The sudden hawkish tilt from the Reserve Bank of India (RBI) and a challenging global backdrop—marked by U.S. tariff actions and shifting domestic tax policies—have compounded the uncertainty.

Yet beneath the noise lies a nuanced story. A closer look at the macro fundamentals, evolving policy dynamics, and external pressures suggests that while risks are evident, opportunities for fixed-income investors may still be found.

The Current Stress Points

Bond yields have been on an upward march, largely because of the RBI’s shift in tone. After months of supportive liquidity and front-loaded rate cuts, the central bank has now moved towards a more cautious, data-driven approach. By signalling restraint on pre-emptive easing, it has pushed investors to reassess future policy support.

At the same time, global factors have cast a shadow. The imposition of steep trade tariffs by the United States—especially on emerging economies like India—has rattled sentiment. India faces an additional 25% penalty on purchases of Russian crude oil effective late August, adding further strain to its external position.

Together, these developments have dented confidence in bonds, with investors fearing tighter liquidity conditions and a possible slowdown in external demand.

Macro Fundamentals Still Supportive

Despite the noise, India’s domestic macro backdrop remains relatively strong. Inflation is benign by historical standards, growth projections remain stable, and the country’s external accounts are underpinned by comfortable foreign exchange reserves.

But the tariff environment is a wild card. With India exporting goods worth $87 billion to the U.S. and enjoying a trade surplus of $41 billion in FY25, higher cumulative tariffs could shave off 0.3%–1% from GDP growth. Labour-intensive sectors like textiles, gems & jewellery, and fisheries are particularly exposed.

A drop in exports could widen the current account deficit beyond 1% of GDP, although this risk would be cushioned if global crude oil prices remain soft. Interestingly, the inflationary impact of tariffs is expected to be muted, if not disinflationary, given the likelihood of weaker consumption, surplus domestic supply, and potential dumping of goods from other markets.

GST Rejigs: Demand Booster or Limited Impact?

On the domestic policy front, the government’s proposed revamp of the Goods and Services Tax (GST) adds another layer of complexity. The plan to simplify the system into two slabs—5% and 18%—with a higher 40% for luxury and sin goods, could reduce effective tax rates for many items.

In theory, lower rates should reduce consumer prices and stimulate demand. However, past experience suggests a more complicated outcome. During the initial GST rollout and subsequent rate cuts in 2017–18, there was little evidence of a meaningful consumption boost. Services inflation even edged higher due to increased taxation under GST.

Brokerages estimate the new rejig could cost 0.3%–0.5% of GDP in foregone tax revenue, while lowering CPI inflation by 40–60 basis points. But producers have historically been quicker to pass on tax hikes than to transmit tax cuts, making the near-term demand boost uncertain.

Policy Makers in a Tight Corner

The combined impact of external tariffs, GST reforms, and slowing tax collections puts India’s policy makers in a bind. On the fiscal front, the government has pledged to reduce debt-to-GDP to below 50% by FY31 from around 56% now. While fiscal prudence has been commendable, further consolidation may prove difficult if revenues falter. That limits the scope for counter-cyclical stimulus in case growth slows.

The RBI, for its part, has shifted its stance from “pre-emptive” to “responsive.” This implies an extended pause in rates, barring a sharp deterioration in growth. Should risks to growth intensify, however, the central bank may again prioritise activity over inflation and opt for additional easing.

For investors, this means the monetary policy environment is likely to remain “lower for longer,” with limited but not absent scope for rate cuts.

What This Means for Bond Investors

For bond markets, the interplay of risks and supports is finely balanced. Rising yields in recent weeks have created headwinds, but the underlying environment of benign inflation, soft demand, and potential policy support still argues against a sustained spike in yields.

From an investment standpoint, the following themes stand out:

1. Duration Play with Caution: The recent rise in yields offers entry points in longer-dated government securities, but investors must be mindful of volatility from global trade developments and domestic fiscal pressures.
2. High-Quality Corporate Bonds: With easy liquidity conditions, spreads on top-rated corporate paper remain attractive relative to sovereign yields. These instruments could deliver better risk-adjusted returns than lower-quality credits.
3. Focus on Liquidity: Given the RBI’s cautious stance, liquidity conditions will be key. Instruments with strong market depth and lower credit risk should be prioritised.
4. Diversification Beyond Borders: For sophisticated investors, diversification into global fixed-income assets may help mitigate risks specific to India’s policy and external environment.

The Road Ahead

India’s bond market is at a crossroads. Tariffs and tax changes have added layers of uncertainty, while the RBI’s hawkish pivot has tempered expectations of near-term easing. Yet the broader macro fundamentals—low inflation, manageable external balances, and prudent fiscal policy—remain supportive.

Investors who can look through near-term volatility and selectively position in quality assets are likely to benefit. The balance of risks is delicate, but the probability of a disorderly rise in yields appears limited. In short, while the bond market has become less comfortable, it continues to offer opportunities for those willing to navigate its complexities with care.

Market this week

Source: BSE and NSE

• The Indian market snapped its two-week winning streak, ending lower by nearly 2 percent as investors turned cautious amid fresh U.S. tariffs on Indian exports and persistent FII selling.
• Hopes of a GST rate cut in the upcoming GST Council meeting provided some support to market sentiment.
• Sectorally, Nifty Realty index declined over 4 percent, Nifty Defence fell 4 percent, Nifty PSU Bank shed 3.5 percent, and Nifty Oil & Gas slipped 3 percent.
• In contrast, Nifty FMCG managed to buck the trend, gaining 0.7 percent.
• FIIs extended their selling spree for the ninth consecutive week, offloading equities worth ₹21,151.90 crore.
• On the other hand, DIIs remained steady buyers for the 20th straight week, purchasing equities worth ₹28,645.04 crore.

Weekly Leaderboard

Source: BSE

Stocks that made the news this week:

RBL Bank on August 29 said its board has cleared a fundraising plan of up to ₹6,500 crore through a mix of equity and debt instruments. The bank will look to raise up to ₹3,500 crore via a Qualified Institutions Placement (QIP) of equity shares, and another ₹3,000 crore through the issuance of debt securities in multiple tranches on a private placement basis.

CG Power and Industrial Solutions gained over 5 percent after its subsidiary, CG Semi Pvt Ltd, launched India’s first Outsourced Semiconductor Assembly and Test (OSAT) facility at Sanand, Gujarat. The company plans to invest ₹7,600 crore to set up two plants in partnership with Japan’s Renesas and Thailand’s Stars Microelectronics. With the commissioning of the G1 unit, CG Semi will provide chip assembly, packaging, testing, and related services, marking a milestone in India’s semiconductor ecosystem.

Meanwhile, shares of textile and footwear companies surged on optimism around possible GST rate cuts expected to be taken up in the upcoming GST Council meeting. Reports indicate the Group of Ministers may recommend lowering GST on items like yarn and rubber thread to 5 percent from 12 percent, and propose raising the threshold for readymade garments under 5 percent GST to ₹2,500 from the current ₹1,000. Garments priced above this threshold may attract 18 percent GST compared to 12 percent at present