Prime Macros: Debt outlook – not yet time for long-term bonds

Bond yields in India, after rising sharply between January and April 2026, have fallen back after the Monetary Policy Committee (MPC) decision on April 8th. While the market was pricing in a hawkish policy, the MPC held on to policy rates and gave out optimistic inflation and growth forecasts. 

The MPC statement forecast India’s FY27 GDP growth at 6.9% despite the Iran war and oil supply disruption. It projected CPI inflation at 4.6% for FY27. It also downplayed worries about the trade balance and the depreciating Rupee. Overall, the projections suggested that MPC thinks the impact of the Iran war will blow over, and that the world will soon be back to business as usual. 

The yield movement in the past few months is given below. The spike in yields and recent MPC action has led some debt market experts and fund managers to conclude that interest rates in India will not head higher from here, making this a good time to lock into long-term bonds. 

We think it is premature to draw this conclusion. There’s a reasonable possibility of inflation rising beyond MPC’s forecasts, prompting MPC to raise policy rates in FY27. Market yields always anticipate MPC decisions and can move up ahead of such rate hikes. Therefore, it appears risky to bet on long-duration debt funds and bonds right now. It would also be prudent to wait for better rates before locking into long-term FDs. Here’s the reasoning for this view. 

Inflation: Upside risks  

In the April 8^th review, RBI forecast inflation for full year FY27 at 4.6%. This is broken down as 4% in Q1 FY27, 4.4% in Q2, 5.2% in Q3 and 4.7% in Q4. In the February review, with no wars or droughts on the horizon, RBI forecast inflation at 4% in Q1 and 4.2% in Q2 FY27. Therefore, the inflation forecasts seem to underplay upside risk to inflation rates from the oil shock and a brewing El Nino. 

#1 Energy prices – Higher for longer 

Even if the US calls a halt to its attacks on Iran (initial ceasefire talks have failed), it appears unlikely that hostilities in the region will cease – with Israel, Iran and Hezbollah in the mix. The oil/gas capacity that has been destroyed in Qatar and Iran cannot come back online immediately. This war will also likely give rise to a next round of energy protectionism among energy buyers, with countries likely to step up stockpiled reserves of oil/gas, adding to supply constraints. Therefore, the geopolitical risk premium on crude oil, which had disappeared for a while will likely return on a durable basis, keeping global oil prices higher than before the war. 

Yes, Brent crude futures have fallen sharply from over $130/barrel to under $100 on ceasefire talks. But less-talked-about Dated Brent prices (which reflect spot prices for cargoes on the sea) remain above $140, signalling that supply constraints have not eased as yet. 

Even if global oil prices correct, what will matter for Indian inflation prints is the price at which Indian oil majors manage to contract crude, LNG and LPG supplies from here on. It appears quite unlikely that Iran will restore free flow of ships through the Hormuz. India has also aggressively diversified its energy sources lately, now sourcing more from Russia, US, Africa and other more distant origins. This will likely mean paying higher prices than in the past. 

Though the Indian government has shielded consumers from price hikes in petrol and diesel through excise duty cuts, rising energy prices will still trickle down to the CPI via higher LPG and ATF prices and transport costs. Supply disruptions in energy usually have a cascading effect on petrochemicals and their derivatives, paints, fertilisers, plastics etc. This will show up in inflation over time. 

#2 Food prices – Brewing El Nino

To arrive its inflation forecast, MPC has assumed a normal South-west monsoon this year. However, global agencies such as the NOAA and Australian Bureau of Meteorology are flagging the possibility of a fairly intense El Nino developing between June and August, coinciding with the peak months of the South-West monsoon.  

Though Indian agriculture has turned more resilient to deficient monsoons in recent years, much depends on the severity of the El Nino. Ten of the 15 drought years experienced by India over the last 50 years coincided with an El Nino. Prices for food crops in the market will spiral on fear of shortages as soon as an El Nino becomes evident, even if the actual harvest in October/November shows resilience. 

All this suggests that the MPC’s inflation forecasts could see significant upward revision as FY27 progresses. History suggests that these can and do get substantially revised (even by a 100-150 basis points) based on incoming data.  

The one silver lining is that the government has recently retained the inflation tolerance band for MPC at 4-6%. Inflation has a good way to go before breaching the 6% mark.  

Capital flows- On shaky ground 

If inflation is the main ‘official’ factor driving MPC actions, the other factor – not overtly talked about – is the state of the Rupee. Higher interest rates attract foreign capital flows into a country, strengthening its currency. Today, the Rupee looks to be in need of such support. 

For over a year now, the Indian Rupee has been under pressure, underperforming other Asian currencies by a significant margin. India has been facing pressures on its capital flows on two counts. One, though India’s gross inbound Foreign Direct Investments (FDI) has remained healthy at $79.3 billion between April 2025-January 2026, compared to $69.2 billion in the same period of FY25, MNCs based in India have been taking out capital due to high market valuations. This has resulted in net FDI inflows dwindling to just $1.7 billion in the April 2025- January 2026 period. 

The second is on remittances, another big source of dollar inflows. There’s worry that large disruptions in the Middle East will prompt Indian workers stationed there to cut back on their remittances. These origins account for about 40% of India’s inward remittance flows.  

The above two apart, the story of FPI flows is well-known. FPIs have engaged in relentless selling in Indian equities due to valuation concerns, a fancy for AI-centric markets and high US yields. After selling $19.7 billion of equities in FY26 they’ve offloaded another $5.1 billion so far in FY27.  

Yes, Indian bond markets have still attracted inflows due to a well-managed fiscal situation. Indian bonds received $18 billion of net inflows in FY26 amid a tight rein on the fisc and the US Fed cutting rates. However, these flows have reversed in the first few months of FY27 ($1.5 billion outflows from debt), on the weakening Rupee, the war and expectations of India’s Current Account Deficit (CAD) widening due to the oil shock. 

All this is not to say that India is heading towards a balance of payments crisis like it did in FY13. With the CAD likely to be below 2% (compared to 6% during the FY13 crisis) and nearly $700 billion of forex reserves which amply cover imports by 11 times, and government debt-GDP at 86%, India still boasts strong macros compared to most advanced economies. 

However, in FY27 India will definitely have a larger current account deficit to finance through dollars. Those dollars will need to come in via FDI or FPI or remittances. Higher interest rates can attract both remittances and FPI flows. 

Growth – Still resilient 

In rate hike decisions, the MPC makes a trade-off between hurting growth on one side and stoking inflation and discouraging capital outflows on the other. 

Currently, most forecasters believe that the Iran conflict does not materially dent India’s growth outlook. Thanks to strong domestic consumption and capex, the Indian economy has enjoyed an exceptional growth spell in the last three years (real GDP growth of 8.2%, 7.1% and 7.6% over FY24/25/26), despite headwinds such as US tariffs. 

The MPC has now forecast a 6.9% real GDP growth for India in FY27. The Chief Economic Adviser had recently projected that as long as oil prices stayed below $90 a barrel, India’s real GDP growth assumptions of 7-7.4% would not need much change. If oil prices remained elevated above $130 a barrel for 2-3 quarters, then these growth estimates could face a 1% downside. The former scenario looks more likely now. In India, moderate inflation is usually good for growth as it lifts incomes and pricing power for companies. 

With inflation and exchange rate concerns likely to outweigh worries about growth, it appears risky to rule out rate hikes and to lock into long duration debt right now. 

Takeaways

For the above reasons, we believe it is too early to determine that rates are headed south and take a duration call. Here’s how the different debt options stack up currently.

• With some likelihood of returning inflation and rising interest rates over the next year, short-term bonds (up to 3 years) and ultra-short, low and short-duration debt funds look to be a good bet. So do floating rate bonds and debt funds investing in them. 
• Fresh investments in long duration funds, with the view of locking in to gains on rate cuts, are best avoided. They will also be subject to high volatility in returns due to the uncertain rate outlook in these times. If you have already invested in these as part of your long-term portfolios, though, it is fine to remain invested.
• FD investors can wait for better rates to lock into long-term deposits. Now is not the time. 
• Within bonds, corporate bonds and State Development Loans (SDLs) currently offer better deals on yields, as their spreads over gilts have risen in the past few months. In corporate bonds, it is best to stick with maturities of upto 3 years. SDLs now offer yields that are 90-100 basis points above g-secs, offering good investing opportunities.