Despite the Reserve Bank of India (RBI) cutting the policy repo rate by 125 basis points in 2025, Indian government bond yields have not decreased correspondingly, revealing a divergence between the bond market and monetary policy. As of December 19, 2025, the yield on the benchmark 10-year government bond concluded at 6.60%, a 0.10% increase since the rate-setting panel's most recent 0.25% cut in the repo rate on December 5.

A primary cause of this issue is liquidity. According to a senior treasury official at a private bank, an additional ₹2–2.5 trillion in liquidity is needed to cool bond yields. The RBI's liquidity infusions are being neutralized by interventions to support the rupee. The market also faces pressure from a substantial ₹4.5-5 trillion state borrowing pipeline in the fourth quarter, which is unsettling investors and increasing term premia. Banks are also shifting from bonds to credit as the credit-to-deposit ratio exceeds 80%.

While the RBI has revealed open market operations (OMOs) and other liquidity measures, these have been largely offset by foreign exchange interventions and bond redemptions, resulting in transient rather than durable liquidity. According to V.R.C. Reddy, Head of Treasury at Karur Vysya Bank, tight liquidity conditions, elevated supply expectations, and global rate volatility have constrained rate cut transmission to the bond market.

Market participants contend that the monetary easing cycle will fail to transmit to the broader economy without a durable infusion of ₹2-2.5 trillion and structural shifts in bank balance sheets.

The front end of the yield curve has remained remarkably stable throughout 2025. The stability shows confidence in the RBI's capacity to manage liquidity and anchor expectations around its revised inflation objective. The absence of sharp movements in one-year yields indicates that markets do not anticipate abrupt policy reversals.

The bearish cycle in India's bond market is anticipated to persist through the remainder of FY26, with the benchmark 10-year government bond yield expected to fluctuate between 6.55% and 6.70%. A mix of structural, cyclical, and one-off factors is driving the ongoing bearishness in bonds, which is expected to keep yields elevated through FY26.

Foreign investors have been net sellers, with net exits for the month nearing 106 billion rupees, adding pressure on bonds. Subdued foreign investor interest, influenced by steep US tariffs and the absence of a US trade deal, may weigh on overall demand.

Concerns have been raised about the potential for a surge in state government bond issuance in Q4. Investor demand from insurance and pension companies remains subdued.

In summary, while rate cuts play a role, liquidity is a critical factor in influencing Indian bond yields. The RBI's efforts to manage liquidity are essential to ensure that monetary policy effectively transmits to the bond market and the broader economy.