This has led to G-Sec yields rising despite the repo rate being cut by a cumulative 100 basis points (bps) in the February-June 2025 period and retail inflation hitting an all-time low of 0.3 percent in October 2025.
That banks’ government bonds have become cautious when it comes to their G-Sec investments is underlined by their trading pattern and the cancellation of a G-Sec auction by RBI on October 31.
The banks’ net purchase of G-Secs shrank to ₹849 crore on November 19, 2025, from ₹6,716 crore on June 6, 2025, according to CCIL data. The RBI’s rate-setting monetary policy committee (MPC) on June 6 cut the repo rate by 50 basis points to 5.50 percent from 6 percent.
The RBI canceled the auction of a G-Sec (6.28 per cent GS 2032), through which the government aimed to raise ₹11,000 crore, as market players sought higher yields (buying the bond at a lower price to the prevailing price in the secondary market).
The yield on the 10-year G-Sec benchmark has hardened by 21 basis points to 6.54 percent since its first issuance in early May 2025.
The return of the previous 10-year benchmark (6.79 percent GS 2034) has increased from 6.29 percent on June 6, 2025 to 6.57 percent on November 20, 2025.
Tamilnad Mercantile Bank Finance Head Arvind Kanagasabai noted that while the banks have fully passed on the 100 basis point cut in repo rate to the external benchmark-based loans that constitute more than 60 percent of their total outstanding floating rate loans, the downward repricing of term deposits is happening with a lag. This therefore puts pressure on the net interest margin.
“So why will banks buy a G-Sec that yields only 6.50 percent when the cost of funds (including the old, expensive outstanding deposits) is higher than that?…So banks have no incentive to buy (G-Secs) now. Previously, the cost of funds was lower than the G-Sec yields,” he said.
Kanagasabai also noted that implementation of the recommendations of the 8th Pay Commission, which will be effective from January 1, 2026, on salary and pension revision for central government employees could result in additional borrowing of over Rs 2 lakh crore in the near future. Additional borrowing could put pressure on G-Sec interest rates.
“Another reason why G-Sec rates could remain high is that average inflation is expected to be at least at the 4.4-4.5 percent level next year. So, the RBI is unlikely to cut rates in December 2025,” TMB’s finance chief said.
The RBI has forecast 1Q27 retail inflation at 4.5 per cent, higher than the MPC’s lower tolerance level of 4 per cent.
Investment guidelines
V Rama Chandra Reddy, head of finance at Karuru Vysya Bank, said the revision in investment guidelines has curtailed flexibility in moving securities from the held-to-maturity (HTM) portfolio, unlike the previous framework that allowed greater maneuverability.
In addition, the turnover from the HTM book is now limited to 5 percent, which severely limits portfolio rebalancing and reduces the opportunities to realize profits from this book. As a result, banks now have limited options to revamp their investment portfolios.
“At the same time, trading book positions remain subject to daily market valuations and P&L impact, making it difficult to take aggressive duration bets in an environment of uncertain interest rate prospects.
“Typically, the spread between the overnight rate and the 10-year G-Sec tends to widen as the rate easing cycle approaches its trough and narrows once the cycle turns. Currently, in the absence of strong directional triggers, lower investor demand and substantial supply from the state government have led to widening spreads,” Reddy said.
Broadening the spread
Venkatakrishnan Srinivasan, founder and managing partner of Rockfort Fincap LLP, opined that despite inflation hitting record lows and the RBI delivering a significant 50 basis point rate cut in June (a total of 100 basis points of repo cut and cash reserve ratio cut each), the long end of the yield curve is driven by much larger forces.
“First, the RBI’s shift to a neutral stance has reduced expectations of quick follow-on cuts and made it data dependent. Second, the government continues to issue a steady supply of 10-year bonds. Third, states are borrowing heavily through SGS auctions, especially in the long term,” he said.
Venkatakrishnan highlighted that this supply pressure comes at a time when the rupee has been weak, FPIs have been net sellers in recent months and global interest rates – including Japanese yields at multi-year highs – are working against Indian maturity.
“Add to that the global risk-off days and geopolitical concerns, and the market is demanding a much higher term premium. That is why the 10-year yield has risen even as the repo rate fell, widening the spread sharply,” he said.
The Rockfort Fincap Chief noted that before the June 2025 policy, the 10-year yield was about 6.25 percent, against a repo rate of 6.00 percent, a spread of 25 basis points.
After the 50 basis point cut, the repo rose to 5.50 percent, but the 10-year yield has refused to soften and is now hovering around 6.54 percent.
The spread has therefore increased to approximately 104 basis points. Simply put, the market has added almost 80 basis points to the term premium compared to pre-policy levels.
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Published on November 21, 2025
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