Stock markets are at all-time highs, and FIIs have invested 5x more in Indian bonds than equities. Where should investors invest ahead of expected RBI rate cut?

The year 2024 has turned out to be an eventful year for Indian bond markets so far. Several major milestones have been achieved, such as the inclusion of Indian bonds in JP Morgan and Bloomberg global bond indexes and S&P upgrading India’s credit rating outlook to ‘positive’ from ‘stable’. Apart from these global factors, the Securities and Exchange Board of India’s (Sebi’s) decision to reduce the face value of listed bonds is also likely to boost the corporate bond market.

Anticipating positive outcomes, the expected rate cuts by the Reserve Bank of India (RBI), and a robust Indian economy, foreign investors are also focusing on Indian bonds. Data available with CDSL showed that FIIs and FPIs have started investing heavily in Indian bonds. While the stock market is at an all-time high, FPIs have invested Rs 75,425 crore in bonds this year and Rs 14,332 crore in Indian equities. This means FIIs have invested five times more in bonds than equities so far this year.

Murthy Nagarajan, Head of Fixed Income at Tata Asset Management, shared his insights on the likely impact of Indian bond inclusion, what options retail investors have in the Indian bond market, where to invest ahead of rate cuts, and more.

BT: What is your suggestion to new investors? What should they keep in mind while investing in bonds?

Murthy Nagarajan: Investors should follow an asset allocation pattern. Expenditures, which are required over the next three years, may be invested in fixed income. This avoids dipping into equity or real estate allocations, given the volatile nature of these assets. Investors should follow the SLR principle, which is about the safety and liquidity of their investments. These two factors should be prioritised over returns while investing.

BT: Ahead of expected interest rate cuts, where should investors put their money? What are the different fixed-income options available for retail investors in India?

Murthy Nagarajan: In a falling interest rate scenario, they could invest in funds with a higher average maturity, like the gilt fund, corporate bond fund, long-term income funds, and dynamic bond fund. 
In a stable interest rate scenario, they should be investing in short-term bond funds, money market funds, and low-duration funds that have an average maturity of 6 months to 3 years. In a rising interest rate scenario, they may be invested in liquid, ultra-short, and overnight funds, which have an average maturity of less than 6 months.

BT: Regarding the inclusion of Indian bonds in JP Morgan and Bloomberg Global Emerging Market Indices, how will it impact the yields and returns, and what benefit could existing Indian investors get from this event?

Murthy Nagarajan: Traders have already built positions based on the inclusion of Indian bonds in global indexes. However, the long-term story is of additional large buyers of Indian government bonds. The government is targeting a fiscal deficit of 4.5 percent of GDP in 2026 and may take the deficit lower in the coming years. This should be a structural positive for bonds due to lower supply and higher demand for government bonds. This will lead to lower government bond yields in the coming years.

BT: How much inflow is expected in Indian bond markets from this inclusion?

Murthy Nagarajan: About $25–30 billion for the current financial year, which are passive flows tracking this index. Another $10 billion is expected from active fund managers due to India's strong fundamentals and the expectation of rate cuts in the US.

BT: S&P Global Ratings revised its outlook on India to positive from stable; how significant is it and how will it impact the Indian fixed income market?

Murthy Nagarajan: SP Global revised its outlook on India to be positive due to a strong focus on infrastructure and lower state and central government deficits due to higher GDP growth. As the GDP growth continues and the total stock of debt as a percentage of GDP comes down, we should see S&P upgrading India’s credit ratings. The market will react as and when steps required for a higher credit rating are taken by the government or RBI and not wait for the S&P rating upgrade. This may lead to lower borrowing costs for Indian entities in the coming years.

BT: If India's credit ratings improve in the near future, how will it benefit investors and corporations thinking of raising capital?

Murthy Nagarajan: Yes, the spread demanded by investors for investing in Indian debt papers will reduce as the risk perception comes down.

BT: What should the ideal bond portfolio for new retail investors look like? How much should be invested in government and corporate bonds, apart from equity?

Murthy Nagarajan: If the economy is doing well, investors may invest in corporate bonds, as their yields are higher than government securities. They may invest in government securities if the interest rates are high due to RBI monetary policy or if downgrades in the corporate sector are expected to increase due to a slowing economy. About 70–80% may be invested in corporate bonds and 20–30% in government securities, under normal market conditions.

BT: What are your expectations for the Indian bond market and overall economy going forward?

Murthy Nagarajan: The economy is expected to be robust due to infrastructure spending by the government and indications of capital expenditure revival by the private sector due to increased capacity utilisation. The global economy is expected to slow down in the coming years due to high interest rates lowering consumption in developed markets.

The ageing population of developed countries could lead to lower GDP growth in these countries. The Indian economy is highly related to the global economy, which could lead to an easing of the growth impulse in the Indian economy. As CPI inflation comes into the 4% band, we should see rate cuts in the Indian economy to boost economic growth.