India Bonds: Demand Slumps, Yields Surge

The Indian bond market is grappling with a notable demand-supply imbalance, resulting in a consistent upward drift in bond yields. This situation has arisen as demand-side incentives for debt instruments have diminished, with regulatory changes nudging long-term investors toward equities. Previously, inflows from index-driven FPIs and RBI's open market operations masked this gap, but tapering flows and reduced liquidity have made the imbalance apparent.

This weaker demand is causing yields to rise even within an easing monetary policy environment. Factors such as banks being constrained by SLR and HTM norms, insurers and pension funds shifting allocations, and FPIs maintaining caution contribute to the fading institutional appetite. Consequently, issuers may need to offer higher coupon rates on new issuances to attract sufficient investor participation.

Despite the challenges, opportunities exist for fixed-income investors. Experts suggest focusing on short-duration funds, corporate bonds, and dynamic bond funds to navigate the elevated yields. These strategies aim to lock in higher rates, manage duration tactically, and capitalize on potential spread expansions, offering a balance between safety and enhanced returns.