The Indian bond market is showing signs of imbalance as demand fails to keep up with supply. Devang Shah, Head of Fixed Income at Axis Mutual Fund, has expressed concern that reduced participation from banks, insurance companies and pension funds is creating a gap that could weigh heavily on the market. Axis Mutual Fund currently manages around Rs 1.25 lakh crore in debt schemes, giving Shah a close view of these shifts.
According to him, one way to address this problem is for the government to reduce the supply of long duration bonds by about three to five percent. This adjustment, he believes, would help relieve pressure in a market where borrowing needs remain high but demand is subdued.
Shah explained that while GST rationalisation is positive for the broader economy and fiscal measures may provide support, the bond market remains sensitive to supply dynamics. He added that with the next pay commission recommendations expected to increase government payouts, fiscal discipline will be tested further in the coming year. Borrowing levels may not rise dramatically in the immediate term, but gross borrowing could increase by Rs 1 to 1.5 lakh crore annually over the medium term.
Yields in the government bond market have already started reflecting these concerns. Shah expects benchmark yields to remain in the range of 6.30 to 6.50 percent in the near future, though any significant fiscal expansion could push them closer to 6.75 percent. While inflation is projected to ease due to GST cuts, giving the Reserve Bank of India some room for a potential rate cut, weak demand for long bonds is limiting investor confidence.
Axis Mutual Fund has responded to this environment by shifting more of its portfolio to shorter duration bonds, where risk and reward appear better balanced. The fund house has also increased its allocation to corporate bonds, which Shah believes currently offer a more attractive opportunity. For investors, he recommends income plus arbitrage funds for medium term allocations, as they offer flexibility to adapt to both falling and rising rate cycles while being more tax efficient. For shorter term needs, money market funds remain a practical choice.
On the flow side, debt schemes saw strong inflows in July, but Shah believes the momentum will not continue at the same pace for longer duration categories. He expects flows into funds with shorter maturities and into newer categories like income plus arbitrage funds to remain steady, as investors prefer more cautious strategies in the current interest rate climate.
The upgrade of India’s credit rating by S&P to BBB from BBB minus has added some positivity to sentiment, particularly for corporate borrowers raising funds overseas, who may now benefit from slightly lower borrowing costs. However, Shah notes that the impact will be incremental rather than transformative.
Looking ahead, he expects some corporate borrowers to shift back towards bank credit once the last leg of rate transmission plays out. Corporate bonds had earlier been more attractive compared to bank loans due to a spread of almost 80 basis points, but as bank rates adjust and credit growth strengthens, a portion of this borrowing is likely to return to banks.
The current scenario highlights the delicate balance that policymakers and market participants must manage. While fiscal measures and reforms provide long term economic benefits, the short term pressure on the bond market cannot be ignored. Ensuring sustained demand for bonds, while managing supply carefully, will be crucial to maintaining stability in India’s debt markets.
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