Indian Mutual Funds Increase Government Bond Sales After RBI Rate Hike

Indian mutual funds have accelerated their selling of government bonds after offloading approximately $4.5 billion since July, as the Reserve Bank of India (RBI) signaled a more aggressive stance on interest rates. Four fund managers confirmed that this trend is likely to extend further, driven by expectations of a prolonged and sharper tightening cycle in response to rising inflation.

In early May, the RBI raised interest rates for the first time in nearly four years, signaling that more hikes could follow. This move has prompted a reassessment of bond portfolios, particularly those with longer maturities. Mansi Sajeja, a fixed-income portfolio manager at SBI Mutual Fund, pointed out that mutual funds have been trimming their holdings of longer-dated government securities due to the changed rate outlook.

Following the RBI’s rate increase, asset managers sold a net ₹5,100 crore (approximately $527 million) worth of government bonds in just three trading sessions. This activity adds to a substantial reduction in holdings during July to September, when mutual funds offloaded ₹37,800 crore in government debt.

Amit Somani, deputy head of fixed income at Tata Asset Management, described the RBI’s policy stance as leaning more towards caution on inflation rather than concerns about growth, giving it a hawkish tilt. Somani expects the yields on long-term bonds to rise further, projecting the 10-year government bond yield could reach between 7.20% and 7.40%. Currently, the five-year bond yield has climbed past 7.05%, rising nearly 70 basis points over two months, while the 10-year yield hovers around 7.35%, levels not seen in almost three years.

Vikas Garg, head of fixed income at Invesco Mutual Fund, highlighted several factors behind the selling pressure. These include the global environment of rising interest rates, historically high global bond yields, the anticipation of an earlier-than-expected interest rate cycle domestically, and ongoing uncertainty in energy markets. These combined risks have encouraged mutual funds to lower duration risk by cutting back on government bonds.

Another significant influence on bond market dynamics has been the RBI’s active open market operations. The central bank sold government securities worth ₹1 trillion in April, marking its highest net sale in more than ten years for any financial year. Such large-scale sales impact demand and supply, affecting bond prices and yields.

With the reduction in long-duration government bond holdings, mutual funds are reallocating assets toward ultra-short duration instruments within both government and corporate debt segments. Axis Mutual Fund, for instance, now favors high-quality corporate bonds with maturities between one and three years. The fund sees these as attractive due to favorable yield carry, strong liquidity, and limited issuance of bank certificates of deposit.

Axis Mutual Fund also indicated the possibility of selectively extending duration when the interest rate hike cycle matures and yields become more appealing. Meanwhile, Aditya Birla Sun Life Asset Management Company prefers ultra-short-term debt instruments, focusing on minimizing interest rate risk. Bandhan Asset Management has notably cut its weighted average bond duration to less than one year, down from around 12 years, demonstrating a shift toward short-term securities to manage volatility.

This change in strategy reflects a broader trend among Indian fixed income investors who are navigating a rising rate environment. As the RBI continues to combat inflationary pressures, mutual funds are adjusting their portfolios to balance risk and returns. The move away from long-duration government bonds toward shorter maturities and corporate debt signals cautious positioning amid uncertainty about how high and how long interest rates will rise.

Given the RBI’s recent actions and forward guidance, market participants remain vigilant. Bond yields are expected to stay volatile as investors weigh domestic inflation trends alongside global monetary policy developments. Mutual funds’ evolving strategies underscore the challenges of managing fixed income portfolios during periods of tightening monetary policy.