Rupee

How India’s Fiscal & Monetary Settings Are Shaping Investment Flows

On October 1, 2025 the Reserve Bank of India’s Monetary Policy Committee left the repo rate unchanged at 5.50% and described stance as neutral, while upgrading its FY26 GDP forecast to 6.8%. The policy note emphasised “policy space” to support growth if needed. On the fiscal side, the Union Budget 2025–26 set a fiscal-deficit target of 4.4% of GDP (budget estimate) after a Revised Estimate of 4.8% for FY24–25 — reflecting gradual fiscal consolidation ambitions. These headline numbers (repo 5.50%; GDP 6.8%; fiscal deficit 4.4–4.8% of GDP) are the starting point for investor reactions.

Direct transmission to bond markets and yields
Monetary calm — a pause or eventual easing — lowers the expected terminal rate and thus puts downward pressure on sovereign yields, all else equal. India’s 10-year G-sec yield traded around ~6.52% on October 1, 2025, after a brief oscillation driven by supply and global rate moves. Lower domestic policy rates or an explicit easing cycle typically compress short-end yields first; longer maturities respond to expectations for growth, inflation and fiscal financing needs. Because India’s fiscal path still implies sizeable market borrowing (net market borrowings remain a multi-lakh-crore exercise each year), the supply-side of debt can offset some rate easing, keeping the curve steeper than peers. Investors therefore watch the 10-year yield as the principal fulcrum for duration allocation.

Effects on equities — valuation and sectoral tilt
A neutral-to-dovish RBI alongside an upward GDP revision lifts the earnings-growth narrative: cyclical sectors (banks, consumer discretionary, capital goods) benefit from higher projected loan growth and consumption. Equity markets priced this in on Oct 1 with domestic indices rallying on the policy decision and bank-stock strength. But two caveats matter for equity investors: sustained outperformance requires earnings visibility — not just rate psychology — and foreign portfolio investor (FPI) activity can swamp domestic flows in the short term. Valuation multiples (P/E and EV/EBITDA) expand when real yields fall; hence, any durable multiple expansion depends on a credible path to lower real rates without fiscal slippage.

FPI flows: sensitivity to yield differentials and risk
Foreign investors trade across fixed income and equities based on relative reward-adjusted carry and near-term political or macro risk. September 2025 saw net FPI selling in equities (reports show continued net sales in September, though at a slower pace), driven by global risk-off and U.S. policy uncertainty. When India’s real yields are attractive — and global risk-on returns — FPIs buy; when global liquidity tightens or political/frictional risks rise, they exit. Hence the RBI’s communication (clarity on rate path) and the fiscal arithmetic (smaller-than-expected deficits) are both key to stabilising FPI flows. A credible glide-path on deficit reduction can reduce risk premia and entice long-duration foreign buyers of G-secs.

FX and the rupee: two-way pressure
Monetary policy and fiscal strategy combine to determine the rupee’s vulnerability to shocks. A dovish RBI may reduce carry attractiveness relative to the U.S., favouring rupee depreciation; but if dovishness is accompanied by stronger growth and narrowing fiscal deficits, that can offset depreciation pressures through improved capital inflows. On Oct 1, 2025 the rupee staged a technical rebound (closing near ₹88.69/USD) after the RBI pause and dollar softness, yet analysts still warn of gradual depreciation absent a durable improvement in the external current account or steady FPI inflows. In short, FX moves are the net outcome of yield differentials, external balances (oil/imports), and capital flow swings.

Interaction of fiscal policy with investor confidence
Fiscal consolidation commitments — moving fiscal deficit from 4.8% (RE 2024–25) toward 4.4% (BE 2025–26) — matter because investors price sovereign risk via both expected supply and macro credibility. A clear, multi-year plan to reduce deficits without choking growth reduces term premia and encourages long-term foreign holdings of government bonds and listed corporate paper. Conversely, fiscal slippage or unanticipated off-budget liabilities would raise required yields and depress both bond and equity valuations. Transparent issuance calendars and predictable bond supply are therefore as important as headline deficit numbers for market functioning.

Practical takeaways for investors
* Fixed income investors should monitor the 10-year G-sec (≈6.5% range) and RBI guidance; favour short-to-intermediate duration if supply risks persist.
* Equity investors can tactically overweight cyclical sectors if growth revisions sustain; manage risk from potential FPI outflows and currency moves.
* Foreign investors will track fiscal consolidation credibility and real-yield differentials versus the U.S./EM peers before committing longer-duration capital.

Conclusion
India’s current policy mix — an RBI pause at 5.50%, an upgraded growth outlook (6.8%) and a fiscal-deficit glide-path toward ~4.4% — creates a constructive but nuanced backdrop for capital flows. Lower-for-longer policy expectations support equities and lower short-end yields, while fiscal credibility and global risk appetite will determine whether foreign investors return in meaningful size to bonds and stocks. For market participants, the interplay of central-bank signalling, budget execution, and external-flow dynamics will dictate asset allocation decisions in the quarters ahead.

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