India’s borrowing costs have climbed sharply as investors prepare for further interest rate hikes by the Reserve Bank of India (RBI). The premium on short-term government debt has reached its highest level in four years. The move follows the RBI’s recent rate hike and a shift toward tighter monetary policy.

At Wednesday’s Treasury bill auction, the government sold six-month and one-year securities at yields of 6.29% and 6.49%, respectively. Both yields reached their highest levels in about 18 months. They also rose by more than 20 basis points from the previous week, reflecting growing expectations of further monetary tightening.

The premium over the RBI’s 5.5% repo rate reached 79 basis points for six-month Treasury bills and 99 basis points for one-year bills. These levels were last seen in November 2022.

Why Are India’s Borrowing Costs Rising?

The recent surge follows the RBI’s first interest rate hike in nearly four years. The central bank raised the repo rate to 5.5% last week and shifted its policy stance, signaling the possibility of further increases.

Governor Sanjay Malhotra added to market concerns on Tuesday. He said monetary policy cannot be viewed separately from financial stability. His comments encouraged traders to factor in a more aggressive rate-hiking cycle.

Investors are also assessing the impact of resilient economic growth and rising inflation. Both factors could influence how long the RBI maintains its tighter monetary policy.

“A clearly hawkish policy guidance and latest commentary has raised terminal rate expectations on the back of resilient growth and higher inflation,” said VRC Reddy, treasury head at Karur Vysya Bank.

Key highlights:

• Six-month and one-year Treasury bill yields reached 18-month highs.
• Premiums over the repo rate hit their highest levels since November 2022.
• Market participants expect further RBI rate hikes amid inflation risks.

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Could Higher Rates Continue Into FY28?

The rise in short-term yields is also changing India’s bond market. The yield curve is flattening as shorter-maturity borrowing rates rise faster than longer-term rates.

Over the past two weeks, the one-year yield has increased by 31 basis points. The five-year and 10-year yields have risen by 26 basis points and 20 basis points, respectively.

Market participants expect the trend to continue if inflationary pressures persist. Higher crude oil prices remain a key risk because they could push inflation beyond the RBI’s comfort zone and increase pressure on the central bank to raise rates again.

Mandar Pitale, Head of Treasury at SBM Bank (India), expects another 50 basis points of rate hikes during the current fiscal year. He added that sustained pressure from higher oil prices could force the RBI to increase rates even in FY28.

Pitale also expects yields across the three maturities to converge when the tightening cycle reaches its peak. For now, rising Treasury bill yields indicate that investors are preparing for a prolonged period of tighter monetary policy. The direction of inflation, crude oil prices and the RBI’s next policy decisions will determine whether borrowing costs continue to climb.