Benchmark yield ends at near 5-month low as index addition bets fuel buying

Indian government bond yields declined, with the benchmark 10-year yield ending at a level seen before the start of rate hike cycle, as investors shifted focus to the prospects of local debt being included in global indexes.

The benchmark 10-year government bond yield ended at 7.1077%, lowest since Apr. 27. It had risen five bps in last two sessions, to end at 7.1811% on Monday. The 10-year 7.26% 2032 bond yield ended at 7.0789%, after closing at 7.1354% on Monday.

The Reserve Bank of India started hiking key policy rate since May 4, leading up to a 140 basis points increase to 5.40% in May-August.

"Index inclusion is the only driving theme for the bond market currently, and since inflation was also not very high, focus has shifted back to inclusion," said Vijay Sharma, senior executive vice president at .

Bond investors have been on a buying spree ever since analysts started betting on local notes likely being included in global indexes.

Foreign investors have stepped up purchases in a clutch of Indian government bonds that have no limits on overseas investment, ahead of the anticipated inclusion, analysts said.

The central bank removed foreign investment caps for a number of securities under the 'fully accessible route' (FAR) in April 2020 to help meet a key requirement of index operators.

"As far as the inclusion goes, the bonds under FAR will be a part of the index as there are no restrictions in that segment," said Ashish Agarwal, Asia head of foreign exchange and emerging market macro strategy research at Barclays.

Meanwhile, India's annual retail inflation rate accelerated to 7% in August, which was above both the 6.9% forecast in a Reuters poll and July's 6.71% reading.

The higher inflation print has prompted some brokerages to raise their calls for a third consecutive 50 basis-point rate hike later this month.

Traders are also looking for cues from the U.S. inflation data due later in the day, which could guide the Federal Reserve policy decision due on Sep. 21.