Indian Debt Funds Set to Extend $4.5 Billion Bond Selloff After RBI Policy Shift
Indian mutual funds have sold about $4.5 billion in government bonds since July as the RBI’s shift towards tighter monetary policy pushes yields higher and encourages fund managers to reduce interest-rate risk.
Indian mutual funds are expected to continue selling government bonds after offloading about $4.5 billion since July, as the Reserve Bank of India’s shift towards tighter monetary policy raises expectations of further interest rate increases.
The RBI raised its benchmark repo rate by 25 basis points to 5.5% on October 7, its first increase since February 2023. It also changed its policy stance from neutral to calibrated tightening, signaling greater concern about inflation. However, the timing and scale of any further increases will depend on incoming inflation and economic growth data.
According to Reuters, mutual funds sold a net ₹51 billion in government bonds during the three trading sessions following the rate increase. That added to net sales of ₹378 billion between July and September. Four fund managers told Reuters they expected selling to continue as investors adjusted to the prospect of a longer period of tighter monetary policy.
The shift reflects a change in how fund managers assess interest-rate risk. Bond prices generally fall when market yields rise because newly issued securities offering higher returns make existing lower-yielding bonds less attractive. Funds holding longer-term bonds can therefore face greater price declines when interest-rate expectations change.
Rising yields put pressure on bond investors
Indian government bond yields have climbed as investors reassess the outlook for monetary policy. Reuters reported that the five-year government bond yield rose above 7.05%, gaining almost 70 basis points over two months, while the 10-year yield approached 7.35%, its highest level in nearly three years.
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Higher yields can improve the income available to investors purchasing bonds at current prices. However, existing holders may experience losses as bond prices adjust, particularly when their portfolios have greater exposure to longer maturities. The actual impact depends on a fund’s duration, holdings, and trading activity.
The RBI’s own bond transactions have added to concerns about market supply and demand. The central bank sold government securities worth ₹1 trillion in September, its largest net sale for a financial year in more than a decade, according to Reuters. Such sales can add to the supply of bonds that investors must absorb, although yields are also influenced by inflation expectations, global interest rates, and demand from banks, insurers, and other investors.
Energy-market uncertainty and rising global bond yields have also contributed to the cautious approach. Together, these pressures have encouraged fund managers to reduce exposure to securities that are particularly sensitive to changes in interest rates.
Fund managers favor shorter-term debt
Some asset managers are responding by shifting towards shorter-duration securities. Reuters reported that Axis Mutual Fund favours high-quality corporate bonds with maturities of one to three years, while Aditya Birla Sun Life Asset Management prefers ultra-short-term debt
Bandhan Asset Management has also reduced its portfolio’s weighted average duration to less than a year, from around 12 years, according to the report.
Shorter-duration portfolios generally experience smaller price movements when interest rates change. This can help limit losses during a period of rising yields, although it does not eliminate credit or liquidity risks. Shorter maturities also mean that investments must be replaced more frequently, leaving future returns dependent on the yields available at reinvestment.
For investors in Indian debt mutual funds, the selloff highlights why a fund’s advertised yield should not be considered in isolation. Two funds offering similar income can deliver different results if one holds longer-term government bonds and the other focuses on short-term securities. Investors need to consider duration, credit quality, liquidity, and their own investment horizon when assessing the risks.
The next direction for bond markets will depend partly on whether inflation pressures persist and whether the RBI signals additional rate increases. If yields rise further, fund managers may remain cautious about longer-term securities. If inflation concerns ease and expectations of further tightening diminish, longer-term bonds could become more attractive at prevailing prices.
For now, the selling reflects a reassessment of interest-rate risk rather than evidence that mutual funds are abandoning Indian government debt altogether.
