Foreign Capital Outflows and Rupee Depreciation Put Pressure on the Reserve Bank of India to Raise Interest Rates

Golden Ten Data reported on June 1 that as investors weigh interest rate hike prospects and growing concerns over government fiscal health, the recent rally in Indian bond yields is likely to continue. Since the outbreak of the Iran war three months ago, the benchmark 10-year government bond yield has risen by around 34 basis points to 7%. IndusInd Bank expects the yield to reach 7.45% by the end of 2026, while Kotak Mahindra Bank anticipates its trading range will be between 6.8% and 7.4% by March next year. The Reserve Bank of India may face pressure to raise borrowing costs in Friday’s rate decision, as the weakening rupee and rising oil prices exacerbate inflation concerns. Although most economists expect the central bank to keep rates unchanged for now, derivatives markets are pricing in aggressive rate hike expectations, with five-year interest rate swaps rising over 60 basis points since the outbreak of the war. Shorter-term government bonds bore the brunt of this selloff, with the five-year yield climbing 54 basis points. Investors will be watching for signs of a more hawkish stance from the central bank. Tata Asset Management and Bandhan AMC project rate hikes of around 75–100 basis points during this cycle.