Note to fixed income investors – Oct 2025
In line with the majority market view, the MPC has decided to keep the policy rate unchanged at 5.5% for the second consecutive meeting. Accordingly, the Standing Deposit Facility (SDF) rate remains at 5.25%, while the Marginal Standing Facility (MSF) rate and the Bank Rates are unchanged at 5.75%. The MPC also maintained its neutral stance.
The measures announced in the June policy have kept system liquidity comfortably positive. Since the last MPC meeting in August, banking system liquidity has averaged a surplus of INR 2.1 lakh crore, which is slightly lower than post-June levels, but still healthy. This indicates that the liquidity impact of the June decisions is still playing out. It has supported improved monetary transmission, as seen in lending and deposit rates, and is expected to further aid transmission, bolstered by the remaining 75 bps CRR cut announced earlier.
Inflation continues to trend lower than the MPC’s August projections, driven primarily by GST rate cuts and easing food prices. However, the policy rate now appears to be close to its terminal level. Moreover, domestic growth remains robust, with the RBI revising its FY26 GDP growth forecast upward to 6.8% from 6.5%, supported by GST rationalization, rising capacity utilization, and improving domestic demand. Any further rate cut would hence be contingent on a negative surprise in GDP growth amid global uncertainties, including tariff policy shifts and risk-off sentiment due to prolonged geopolitical tensions.
The bond market reacted positively to the policy announcement, with the 10-year G-sec yield settling at 6.54%, which is a couple of basis points lower than the previous close. It continues to trade within a narrow band of 6.51%-6.59%, having risen ~21 bps over the past two months due to increased government borrowing and the fiscal impact of GST rationalization. Lately, short-term rates have moderated significantly, supported by rate cuts and surplus banking system liquidity. The term spread between the 3-month T-bill, and the 10-year G-sec is now ~110 bps, close to the long-term average of ~120 bps. In the near term, the 10-year G-sec is expected to remain range-bound in the absence of any adverse developments.
Strategy for fixed income investors
- With the decline in G-sec yields over the past twenty months, our overweight stance on duration has played out reasonably well. As highlighted in previous notes, we shifted to a neutral stance and continue to expect limited capital gains from further rate declines. Long-term yields may remain sensitive to evolving growth-inflation dynamics.
- Corporate bond spreads remain muted, with AAA spreads still below long-term averages due to limited supply. In select cases, AA and A-rated bonds offer attractive spreads after adjusting for risk. Investors with a higher risk appetite may consider evaluating select high-yield strategies.
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