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Informist, Tuesday, Aug. 5, 2025

MUMBAI – The structural factors underpinning the "rally" in longer-duration government bonds over the past 12-15 months have faded, and the move downward in yields of these bonds is largely done, Axis Asset Management Co. said in a report. With a limited scope for further rate cuts by the Reserve Bank of India's Monetary Policy Committee and deteriorating demand-supply dynamics in longer tenure bonds, a further fall in yields for bonds maturing in 15-50 years is unlikely, the report said. 

According to the fund house's calculation, there is a mismatch of INR 1.16 trillion between the supply of long-term central and state government securities in 2025-26 (Apr-Mar) and the appetite of long-term investors such as insurance companies, provident and pension funds. Favourable demand-supply had been a key reason for the sharp fall in yields since the beginning of FY25. The yield on the 30-year benchmark gilt fell to a low of 6.74% in April from 7.13% as of March-end 2024.

"Furthermore, we believe that the end of the rate cut cycle and changes in the Held to Maturity (HTM) guidelines, participation from banks, mutual funds and FPI (foreign portfolio investors) would be limited and would not be sufficient to bridge the gap," Fixed Income Head Devang Shah wrote in the report. Pension schemes have been allowed to increase investment allocations to equity, and the RBI said last year that 14- and 30-year bonds will no longer be eligible for FPIs without limits.

While the fiscal deficit is expected to narrow to 4.4% of GDP in FY26, the scope for further consolidation is limited due to weaker tax revenues as growth is slowing down, the 8th Central Pay Commission spending outlays, probable fall in Reserve Bank of India's dividend payout to government, and a shift in fiscal metrics from focussing on deficit to Centre's debt-to-GDP ratio. Gross borrowings for both central and state governments are expected to rise in FY27, which could potentially cause a strain on the bond market, Axis AMC said.

Moreover, the yield curve generally steepens near the end of a rate cut cycle, limiting the scope for a fall in longer tenure bond yields. So far in 2025, the spread on the 30-year benchmark gilt over the 10-year benchmark gilt has already widened by 44 basis points as the RBI's rate-setting panel cut the repo rate by 100 basis points, and signalled that further rate cuts are not expected to be large, the report said. Shah has only one government security maturing after 2039 in his Axis Strategic Bond Fund.

"The RBI's shift to a neutral stance signals that aggressive rate cuts are unlikely," the fund manager said. "With operative rates already eased by 150 bps, any further cuts may be limited to just one more or two at best in case the growth surprises on the downside."

The report also said that with INR 12 trillion already injected through the cut in cash reserve ratio for banks and other tools used by the RBI, and ample liquidity surplus, the need for further open market operations by the RBI was minimal. Further, flows from FPIs have also dried up, with net outflows of INR 139.92 billion over the last four months through the fully accessible route. Most flows related to India's bond inclusion into JP Morgan's Government Bond Index – Emerging Markets and Bloomberg's Emerging Market Local Currency Government Index have already happened, leaving little room for incremental demand, the report said. A risk to the fund house's assessment is if India's bonds are included in Bloomberg's global aggregate indices, it said.

Real-money investors with long-term liabilities could still find value in long-term bonds if they are able to withstand short-term volatility. Tactical opportunities offering 10-15 bps could also emerge intermittently, Shah said. Investors should consider shifting to short-duration or opt for accrual strategies. Corporate bonds maturing in two to five years offer better risk-adjusted returns as the yield curve steepens, the report said.  End

Reported by Srijita Bose

Edited by Saji George Titus

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