Escalating geopolitical tensions between India and Pakistan have triggered a significant sell-off of Indian government securities (G-secs) by foreign banks and primary dealers. Over a span of two days, these institutions offloaded nearly $3 billion worth of G-secs, reflecting concerns about a potential wider military conflict and a subsequent flight to safety.

The tensions arose after India launched missile strikes on Pakistan on May 7, 2025, in response to a terrorist attack in Pahalgam that killed 26 civilians. India stated that the operation, codenamed "Operation Sindoor," targeted militant groups, while Pakistan claimed that the strikes hit civilian areas. These events led to increased cross-border skirmishes and drone strikes, further intensifying the geopolitical uncertainty.

The sell-off by foreign banks had an immediate impact on the Indian bond market. The yield on the 10-year benchmark government bond rose by six basis points, reaching its highest closing level since April 15, 2025. This increase in yield indicates a decrease in bond prices, as investors demand a higher return to compensate for the perceived risk. The Indian rupee also experienced a sharp decline, recording its largest intraday drop since 2022.

However, following a ceasefire announcement, traders anticipated a cooling of geopolitical risks, which could lead to a decrease in yields by 4-5 basis points. Experts believe that the 10-year benchmark is likely to stabilize around 6.32-6.34%.

Despite the recent volatility, some analysts remain optimistic about the Indian bond market's long-term prospects. They point to India's strong macroeconomic fundamentals and the expectation of future interest rate cuts by the Reserve Bank of India (RBI) as factors that could support bond prices. However, they also caution that short-term sentiment and capital flows will heavily depend on developments in the India-Pakistan situation and global cues, particularly the movement of US Treasury yields.

The situation highlights the sensitivity of financial markets to geopolitical events. Heightened tensions can trigger risk aversion, leading investors to reduce their exposure to emerging markets like India. This can result in capital outflows and downward pressure on asset prices.

The India-Pakistan conflict has a long history, with tensions often centered around the disputed region of Jammu and Kashmir. The recent escalation and the ensuing market reaction underscore the need for peaceful resolution and de-escalation of tensions to maintain stability in the region and foster investor confidence.