A key rub-off of the positivity around the fiscal path set out by the Finance Minister in her Budget speech has been on the bond markets. Conservatively placing fiscal deficit at 5.8 per cent for the current year was fine. But a healthy 5.1 per cent in FY25 surprised most in the fixed-income markets. More so after the gross and net borrowing numbers of the government were placed quite moderate at ₹14.13 lakh crore and ₹11.75 lakh crore.

Yields soften at longer end

Given that the Reserve Bank of India (RBI) has been on pause mode and inflation has generally followed a downward trajectory for the past one year, yields on government bonds have generally been rangebound at 7.1-7.4 per cent broadly barring the occasional spikes due to geopolitical cues and the US Federal Reserve’s moves.

With the budget’s strong fiscal consolidation move being a major positive, the yields on government securities maturing in 2028, 2030 and 2033 have gone well below the 7.1 per cent mark. The 10-year g-sec is now available at yields close to 7.06 per cent according to data from CCIL. In fact, the g-sec maturing in 2028 trades at a yield of 6.99 per cent, while the sovereign bonds maturing in 2030 are available at 7.05 per cent yield. These are a good 15-25 basis points lower than their highs in 2023.

However, at the other end of the curve, the yields on securities maturing within one-year or earlier are still fairly high, thanks to the tight liquidity in the banking system. Indeed, there has been a liquidity deficit for the past several months. As of January 24, the deficit touched a record ₹3.5 lakh crore even as the RBI held variable rate repo actions to infuse liquidity.

 The 364-day treasury bills maturing in January 2025 trades at a yield of 7.13 per cent, while the 182-day security maturing in July 2024 are available at 7.12 per cent. Even the 91-day treasury bill carries a yield of 6.93 per cent. Elsewhere, the one-year commercial paper trades at a yield of 7.95 per cent, while the one-year certificate of deposit is at 7.91 per cent. These two are popular corporate borrowing instruments.

On the whole, the short-term yields are at a premium to those on longer term securities and this would continue till the liquidity remains tight.

What can investors do?

Indian bond holders have a bit to look forward to for the rest of 2024. The inclusion of Indian securities in JP Morgan’s Bond index would bring in a likely $23 billion in inflows from June 2024 to March 2025. Bloomberg is also reportedly considering addition of Indian gilts in the its emerging markets local currency index.

Together with the fact that interest rates may start softening towards the last quarter of CY2024, there is scope for bond yields to fall further. This decline in bond yields of longer-tenure securities would mean a rally in bond prices as they share an inverse relationship.

Investors can thus consider five-year and ten-year gilts or gilt funds for reasonable yields and possibly capital appreciation. ICICI Prudential Gilt, SBI Magnum Gilt and Kotak Gilt that have average maturity profiles of 5.75 to 12 years can be good choices.

To play the relatively higher yields at the shorter end, liquid and money market funds can be considered. Aditya Birla Sun Life Liquid, Nippon India Liquid and Mahindra Manulife Liquid are good fund choices. SBI Savings, HDFC Money Market, Nippon India Money Market and Aditya Birla Sun Life Money Manager can be good additions, too, for investors looking to make the most of higher short-term yields.