Indian government bond yields edged higher on Thursday, with the benchmark 10-year yield climbing above 6.5%, as traders turned cautious amid fiscal concerns following the government's proposed overhaul of the Goods and Services Tax (GST) structure.

The 10-year benchmark yield was at 6.5012%, compared with the previous close of 6.4969%, reflecting subdued demand for sovereign debt after Prime Minister Narendra Modi, in his Independence Day speech, outlined a simplified GST framework.

The Group of Ministers (GoM) on GST rationalisation has accepted the Centre's plan to shift to a two-slab structure of 5% and 18%, scrapping the existing 12% slab, while retaining special rates for select categories. The GST reforms, aimed at easing compliance and boost consumption, are expected to have near-term revenue implications.

With yields now trading above the Reserve Bank of India's policy repo rate of 5.50%, bond traders are bracing for higher government borrowing and potential inflationary pressures.

"We estimate GST changes-led general government revenue loss of ~0.4% of GDP on an annualised basis, with states bearing a disproportionate hit. Assuming no changes in expenditure, we estimate the Centre's FY26 net fiscal slippage at ~0.2% of GDP, with lower direct and indirect taxes being partly offset by revenue buffers such as higher dividends and PSU divestments," said Madhavi Arora, Lead Economist at Emkay Global Financial Services.

Echoing a similar view, Pallav Bagaria, Director at Sapient Finserv, said the rise in yields reflects investors pricing in near-term fiscal concerns and potential revenue loss. "However, this should be seen as short-term pain for long-term gain. Lower GST rates will put more money in the hands of consumers, potentially boosting demand and widening the tax base over time," he said.

With lower GST slabs and lesser compliance, tax collection will broaden over the next few years, he added.

Yield Curve Slope

The spread between the RBI repo rate at 5.50% and the 10-year government bond yield at recent high of 6.54% stands at around 104 basis points, reflecting a modestly upward-sloping yield curve. This suggests that investors anticipate some level of inflation and growth over the medium to long term, but not a scenario of runaway inflation.

While short-term borrowing costs linked to the repo rate remain relatively moderate, long-term borrowing — such as corporate bonds and infrastructure loans — currently carries an additional cost of about 1 percentage point. Analysts said this indicates tighter conditions for long-term financing, though the differential is not excessively high by historical standards.

Market participants also pointed to Friday's scheduled debt auction, where the government will sell bonds worth ₹36,000 crore, including ₹30,000 crore of the 10-year benchmark note. The cut-off yields at the auction will be closely watched as an indicator of investor appetite for sovereign paper amid fiscal uncertainties.

Credit Rating Upgrade Offers Temporary Relief

Bond yields found some respite after global rating agency S&P upgraded India's sovereign credit rating to BBB with a Stable Outlook. The upgrade sparked a rally in government securities, with expectations that the move would attract greater foreign and portfolio investor participation in the bond market.

However, analysts noted that the relief was short-lived as concerns over fiscal slippage following the proposed GST reforms capped gains and limited the rally.

Impact on Equities 

Analysts also flagged that rising bond yields could also weigh on interest rate sensitive sectors in the equity markets.

"Sectors sensitive to interest rates, such as real estate, NBFCs, and utilities, face higher borrowing costs and reduced demand. Mid-cap firms with high leverage are particularly vulnerable. There can be outflow from equities to bonds in the near term leading to some correction in the equity market," said Purvi Mundhra, Economist at Systematix.