Short-term Indian government bond yields fell to their lowest in three months on Wednesday, steepening the yield curve to a one-year high on expectations that banks will invest funds raised under the RBI's dollar inflow measures in this segment.On Friday, the Reserve Bank of India unveiled steps to attract dollar inflows, including fully ‌subsidising hedging costs ⁠on ⁠foreign currency deposits raised from non-resident Indians.The subsidy covers non-resident deposits with maturities of three to ​five years raised until September 30.India bond demand wanes as US-Iran tensions lift oilIndian government bonds saw reduced demand on Thursday. Renewed U.S.-Iran strikes pushed oil prices higher. This development raises concerns about India's economy, the world's third-largest oil importer. Foreign banks sold Indian bonds, marking a significant outflow. Economists predict mounting costs if the conflict persists. Inflation is expected to average 5.1% with growth slipping to 6.6%.With the RBI absorbing hedging costs, banks can convert dollar deposits into rupees more cheaply, giving them access to lower-cost funding that is expected to flow into investments, including government bonds.Yields on two- to five-year ​bonds have fallen by up to 30 basis points, ⁠led by ‌the 6.36% 2031 bond, which has accounted for about $500 ​million of the ​roughly $1 billion in foreign purchases over the past three ⁠days."The rally is being driven by expectations that a portion of funds raised by banks under the RBI's scheme will be channeled into shorter-duration bonds," said Binod Kumar, managing director and CEO at Indian Bank.The gap between five- and 10-year yields has widened to a one-year high of 40 basis points, more than double its pre-policy level. The five-year yield has fallen more sharply than the 10-year.Ashwin Patni, head of ‌wealth management solutions at Julius Baer India, said the short to medium end of the curve currently offers a more favorable ​risk-reward trade-off ​compared to the longer ⁠end, which remains more sensitive to global factors and fiscal dynamics.Investors expect a further steepening of the curve, with more inflows likely in the coming days ​and the up-to-five-year segment remaining in favor."We expect incremental inflows to the tune of around $5 billion in the immediate future in response to these announcements, aided by tax exemptions and expectations of improved performance of INR vs other Asian currencies," Parul Mittal Sinha, head-markets, India and South Asia at Standard Chartered Bank, said.