Indian Bonds Face Pressure Amid Rising Supply Concerns

India's corporate bond market has entered a pivotal phase, marked by record-breaking issuance and a complex interplay of risks and opportunities. As of August 2025, total corporate bond fundraising in India has neared ₹10 trillion for the year, driven by historically low interest rates, aggressive capital expenditure, and a shift in corporate financing strategies. However, beneath this optimism lies a growing unease: rising supply pressures, liquidity constraints, and structural imbalances threaten to undermine the market's long-term health. For investors, the challenge is to navigate these dynamics while capitalizing on the opportunities emerging from regulatory reforms and evolving yield landscapes.

Drivers of Growth and Emerging Risks

The surge in corporate bond issuance is a direct consequence of the Reserve Bank of India's (RBI) aggressive rate-cutting cycle. Between February and June 2025, the RBI reduced the repo rate by 100 basis points, bringing it to 5.5%. This has slashed borrowing costs for corporations, making bond markets a more attractive alternative to traditional bank loans. For instance, non-financial corporate capex has grown at a double-digit pace, with firms like Power Grid Corp and Delhi International Airport leveraging favorable rates to fund infrastructure projects and refinance legacy debt.

Yet, this growth is not without risks. The market is increasingly dominated by high-rated public sector undertakings (PSUs) and financial institutions, which account for over 80% of total issuance. While this concentration ensures credit quality, it also limits diversification for investors seeking exposure to mid-sized or niche-sector corporates. Furthermore, the reliance on institutional investors—mutual funds, insurance companies, and banks—has left retail participation at under 5%, stifling liquidity and price discovery.

Liquidity Challenges and Secondary Market Gaps

One of the most pressing issues is the underdeveloped secondary market. Despite robust primary issuance, secondary market turnover remains below 4% of outstanding bond volumes, with over-the-counter (OTC) trades dominating. This lack of liquidity creates a mismatch between the demand for bonds and the ability to trade or exit positions. For example, even as ₹2.79 trillion was raised in Q1 2025, the average daily turnover in corporate bonds has hovered around 1.9% of outstanding volumes, highlighting the fragility of the market.

Regulatory reforms, such as SEBI's introduction of online bond platforms and reduced minimum investment thresholds, aim to address these gaps. However, progress is slow. Retail investors, who could inject much-needed liquidity, remain hesitant due to high entry barriers and a lack of transparency in pricing. Meanwhile, institutional investors, while dominant, are increasingly cautious about longer-duration bonds amid global macroeconomic uncertainties.

Global Pressures and Yield Dynamics

India's bond market is also feeling the ripple effects of global macroeconomic shifts. The U.S. Treasury yield curve, which has steepened due to rising long-end yields, is influencing investor behavior worldwide. As global capital flows shift toward high-grade instruments and shorter-duration debt, Indian corporates face pressure to offer competitive spreads. For instance, the 10-year G-Sec yield has remained range-bound between 6.25% and 6.45% since April 2025, despite domestic rate cuts—a reflection of external capital flows and risk-averse sentiment.

Opportunities in a Shifting Landscape

Despite these challenges, the market offers compelling opportunities for discerning investors. Regulatory interventions, such as SEBI's push for market-making activities and credit derivative usage, are beginning to improve secondary market depth. Additionally, the inclusion of Indian bonds in global indices like the JP Morgan GBI-EM index is expected to attract foreign inflows, further diversifying the investor base.

For investors, the key lies in balancing risk and return. High-quality, shorter-duration bonds—particularly those issued by AAA-rated PSUs and infrastructure firms—offer attractive yields in a low-interest-rate environment. For example, Power Grid Corp's 5-year bonds currently yield around 6.8%, outperforming traditional savings instruments. Meanwhile, investors with a higher risk appetite may explore AA+ or AA-rated papers, where spread compression opportunities exist.

Investment Strategy: Navigating the New Normal

1. Diversify Across Tenors: Given the volatility in interest rates, a mix of short- and medium-term bonds can mitigate duration risk.
2. Leverage Regulatory Reforms: Take advantage of SEBI's online bond platforms to access a broader range of issuers and improve liquidity.
3. Monitor Global Signals: Track U.S. fiscal developments and global bond yields to anticipate shifts in capital flows and investor sentiment.
4. Focus on Credit Quality: Prioritize AAA-rated issuers and PSUs, which remain less vulnerable to liquidity shocks.

Conclusion

India's corporate bond market stands at a crossroads. While the surge in issuance and favorable rate environment present opportunities, structural challenges—liquidity constraints, issuer concentration, and external pressures—demand careful navigation. For investors, the path forward lies in adopting a strategic, diversified approach that balances yield potential with risk management. As regulatory reforms gain traction and global dynamics evolve, the market's ability to adapt will determine its long-term resilience.