India’s bond market could be entering a more challenging phase as elevated global yields, rising crude oil prices and higher domestic inflation risks put pressure on the outlook for interest rates. After the easy gains from the recent bond rally, investors may now need to be more selective about duration and focus on the risks they are being compensated for.
Archit Shah, Chief Investment Officer at Zurich Kotak General Insurance, expects the RBI to potentially hike policy rates by 50-75 basis points, taking the repo rate towards 5.75-6% from the current 5.25%, if inflation, crude prices, the rupee and global yields remain under pressure.
Shah expects the Indian 10-year government bond yield to remain elevated around 7% in the near term, with a bias towards 7.25% if these pressures persist. Rather than making a large directional duration call, he prefers carry and roll-down strategies and believes investors should wait for a better margin of safety before adding duration.
In this edition of ETMarkets Smart Talk, Shah discusses the outlook for RBI policy, Indian bond yields and fixed-income markets, the impact of the US Fed’s tightening cycle, and how investors can build more resilient portfolios amid rising correlation and liquidity risks. Edited Excerpts:
Q) What does portfolio resilience mean in 2026, amid rapidly changing geopolitical, trade, currency and interest-rate dynamics?
A) For me, portfolio resilience is about being prepared for different outcomes rather than trying to predict one particular outcome. The market is being driven by several factors at the same time: geopolitics, oil, currencies, global rates, and domestic inflation, and these factors can interact in ways that are difficult to predict.
I also think diversification needs to go beyond simply owning different asset classes. We need to look at the risks within them like duration, credit, liquidity, currency and equity risk.
A resilient portfolio is one that can withstand an unexpected change in the macro environment without forcing you to make decisions at the wrong time. The ability to remain liquid and retain flexibility during a market dislocation is itself an important part of portfolio resilience.
Q) What could be the immediate impact on Indian debt and equity markets if the US Federal Reserve resumes tightening?
A) The Fed has now moved into a tightening phase, raising the federal funds target range by 25 bps to 3.75-4.00% in September, with policymakers signaling the possibility of another hike this year.
For India, the more important transmission channels are likely to be US Treasury yields, the dollar and global financial conditions, rather than the Fed's 25 bps move in isolation. For bonds, the longer end of the Indian curve is likely to remain sensitive to movements in US yields and global risk premia.
For equities, the impact will be more differentiated, as higher global yields raise the hurdle rate for valuations. The key issue for India is therefore how high global yields remain and how persistent dollar strength becomes. If the global rate cycle remains higher for longer, domestic financial conditions can tighten even without an immediate change in the RBI's policy rate.
Q) Could a stronger dollar and higher US yields put pressure on the rupee and constrain the RBI’s room for monetary easing?
A) Yes. A stronger dollar and higher US yields can put pressure on the rupee through capital flows and the relative attractiveness of global fixed income.
For the RBI, the issue is less about whether it has the ability to cut rates and more about whether the macro environment allows it to do so comfortably. If inflation is moving higher at the same time as the currency is under pressure, the room for aggressive easing naturally becomes more limited. India does have buffers and several policy tools, so I would not look at this mechanically.
However, the combination of higher global yields, a weaker currency, elevated crude prices and rising domestic inflation is clearly less supportive of monetary easing. In fact, the balance of risks is increasingly shifting from how much the RBI can ease to how much tightening is required if these pressures persist.
Q) With equity valuations remaining elevated in some segments, does portfolio resilience require reducing equity exposure or becoming more selective?
A) I don't think portfolio resilience necessarily means reducing equity exposure. It means being more selective about the risks being taken at current valuations.
When valuations are high, the margin for an earnings disappointment becomes smaller. So, I would put greater emphasis on earnings visibility, balance sheet strength, and the sustainability of growth.
There is also a difference between reducing equity exposure and reducing exposure to areas where the risk-reward has become less attractive. For a long-term investor, equities will continue to have an important role in wealth creation.
But at this stage, I would rather be selective than make a broad call to reduce equities. The focus should be on what you are paying for the growth you are buying.
Q) What is the biggest portfolio risk investors may currently be underestimating?
A) I think it is correlation risk. Investors often feel diversified because they own equities, bonds, gold and other assets. But during a macro shock, these assets can start responding to the same underlying factor.
For example, higher oil prices can push up inflation, put pressure on the currency and lead to higher bond yields, while also affecting corporate margins and equity valuations. So, I would focus not just on diversification across asset classes, but on diversification across the risks within those assets.
Liquidity is another risk that is often underestimated. It looks abundant when markets are calm, but it can disappear quickly during stress.
Q) What factors provide confidence in India’s debt market over the long term, despite global yields and capital flow volatility?
A) There are several structural factors supporting the Indian debt market. Domestic savings are increasing, institutional participation from insurance and pension investors is deepening, and the government securities and corporate bond markets have become more mature. The investor base is also becoming broader, which should help the market over time.
Having said that, I would separate the long-term structural opportunity from a short-term duration call. India can have a strong long-term bond market story, and, at the same time, long duration bonds can go through periods of volatility. The structural story remains strong, but the price at which you enter still matters.
That is particularly relevant today because Indian bonds are competing for global capital with higher-yielding developed market fixed income, while global yields and currency risks remain elevated.
Q) With the US Fed back in a rate-hiking cycle and the Indian 10-year yield around 7%, how should investors rethink the fixed-income opportunity in India right now?
A) I would not look at 7% in isolation and conclude that long-duration bonds are automatically attractive. The India-US 10-year yield differential is around 200 bps, but the important question is what that spread is compensating you for.
When domestic inflation risks are rising and global risk-free yields are also elevated, the same spread is less attractive than it would be in a benign inflation environment. The global opportunity set also matters. With US 10-year yields elevated, Indian bonds have to offer adequate compensation for duration and currency risk.
I would expect the Indian 10-year yield to remain in a relatively elevated range around 7% in the near term, with a bias towards 7.25% if oil, global yields and domestic inflation remain elevated. A move towards 7.25-7.35% would become a risk scenario if these pressures persist.
At current levels, I would prefer carry and roll-down over taking a large directional duration call. The opportunity in fixed income is increasingly about being paid adequately for the risks taken, rather than simply chasing duration because yields appear high in absolute terms.
Q) The RBI has already delivered significant rate cuts, while inflation is moving higher. Do you think the easy part of the Indian bond rally is behind us, or can bond yields still move lower from here?
A) I think the easy part of the rally is behind us. That does not mean yields cannot move lower from here. But for another meaningful duration rally, we probably need a more supportive combination of factors: lower inflation, a stable currency, benign global yields and favourable liquidity conditions.
The current environment is more complicated. Global yields have moved higher, the rupee remains sensitive to external pressures and domestic inflation risks have increased.
More importantly, I think the next phase of monetary policy needs to be viewed through both the rate cycle and the liquidity cycle. The large FCNR(B)-related foreign-currency inflows have contributed to a substantial surplus of rupee liquidity in the banking system.
The special window attracted around $133 billion through FCNR(B) and total foreign-currency inflows across the facility were around $143.6 billion. The RBI has already been using VRRR operations and OMO sales to absorb this liquidity.
For a rate-hike cycle to transmit effectively into broader financial conditions, surplus system liquidity will need to be progressively normalised. Excess liquidity can keep overnight rates below the policy rate and dilute the initial transmission of a repo rate increase. Against this backdrop, we see 50-75 bps of cumulative rate hikes as a reasonable range, potentially taking the repo rate towards 5.75-6% from the current 5.25%.
A move beyond 6% cannot be ruled out, but the extent of further tightening would remain data-dependent, particularly on inflation, crude prices, INR stability and global yields. So, I would not become negative on bonds.
I would be more patient on duration; favour carry and roll-down and look to add duration when the margin of safety improves.
Q) For retail investors looking to invest in Indian bonds today, how should they choose between government securities, high-quality corporate bonds, target-maturity funds and short-duration funds in this environment?
A) It should start with the investor's time horizon rather than the product. Government securities are appropriate for investors prioritising sovereign credit quality, but longer maturities can have significant price volatility.
High-quality corporate bonds can provide additional carry, but investors need to consider credit and liquidity risk. Target-maturity funds can be useful when the investor has a defined horizon and is comfortable with the maturity profile of the portfolio. Short-duration funds offer greater flexibility and lower sensitivity to changes in interest rates.
So, I would ask three questions: What is my investment horizon? How much volatility can I tolerate? Am I being adequately compensated for the duration, credit and liquidity risks I am taking?
In the current environment, I would be cautious about chasing yield simply because the headline number looks attractive. The objective should be to earn adequate carry while maintaining enough liquidity and flexibility to take advantage of better opportunities when market conditions change.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times.)
