India bond yields rise on oil spike, index hopes limit losses

Indian government bonds declined early Monday, with the benchmark 6.94% 2036 bond yield rising to 6.7340% as of 10:25 a.m. IST. The move reversed a four-basis-point gain from Friday, which had marked the bond's best session in a week.

The selloff was driven by a surge in crude prices following weekend military strikes between U.S. and Iranian forces. Brent crude futures jumped 4% in Asian trading to $79 a barrel after Iran claimed to have closed the Strait of Hormuz, a claim disputed by Washington.

Higher oil prices pose a direct threat to Indian inflation, particularly as the country is the world's third-largest oil importer and consumer. Traders noted that a domestic monsoon deficit is already stoking price pressures. This combination complicates the economic outlook and leaves the central bank with limited room to ease monetary policy.

Indian bonds also mirrored a broader U.S. Treasury rout, with the 10-year U.S. yield adding 1.6 basis points to reach 4.5834%. This offshore pressure pushed Indian overnight index swap rates higher, with the one-year rate climbing 5 basis points to 5.82% and the two-year rate rising 4.75 basis points to 5.9650%.

Despite these headwinds, market participants expect the downside to be cushioned by robust foreign demand and a potential benchmark upgrade. Bloomberg Index Services is expected to announce a decision on including Indian debt in its Global Aggregate Index later this week.

"Yields should settle after the initial spike, as expectations of inclusion in Bloomberg's Global Aggregate Index are likely to limit selling pressure," a private-bank trader said. Overseas investors have already purchased more than $1 billion of Indian government bonds in July through the fully accessible route, attracted by recent policy measures and tax breaks.