From FPI flows to bond yields: Tata AMC's Amit Somani explains the key risks and opportunities in fixed income 

Indian markets are facing pressure from rising geopolitical tensions, higher crude oil prices and movements in global bond yields. These factors have contributed to a widening current account deficit, a weaker rupee and higher inflation concerns, leading to an increase in bond yields.

In an interaction with Business Today, Amit Somani, Deputy Head-Fixed Income at Tata Asset Management, explains how investors should assess these risks, the role of foreign portfolio investors (FPIs) in Indian bonds, whether the market currently offers an attractive risk-reward opportunity, and where the biggest opportunities lie in India's fixed-income space. 

Q) Global uncertainties, from geopolitical tensions to movements in US bond yields, continue to affect markets. How are these factors influencing India's fixed-income market? 

Amit Somani: Geopolitical risks have driven up crude oil prices, which has expanded India's current account deficit (CAD) from well under 1% over last couple of years to an expected 2.0%-2.5% of GDP levels in the current fiscal year. This widening CAD has pressured the currency, causing a sharp rupee depreciation over the past three months. Additionally, the ongoing conflict has caused logistical disruptions and scarcity for various commodities, raising inflation expectations. Driven by these three distinct pressures—a widening CAD, a depreciating currency and rising inflation expectations—bond yields have moved up by roughly 50 to 75 basis points over the last two to three months. 

MUST READ: Edelweiss Mutual Fund launches India’s first hybrid index fund combining equities, G-Secs; should do you get it?

Q)  India's bond market is still much smaller than those of major economies such as the US and China. What steps are needed to deepen the market and unlock its full potential? 

 Somani: The Indian fixed-income market predominantly comprises of government securities (G-Secs) and very high quality (AAA-rated) securities. Lower rated issuers will need to be encouraged and provided access to tap the bond market. This will require increased effort/support on part of various regulatory agencies to work on creating standardised requirements that such companies can fulfil or follow. It is also important to have a legal framework that provides prompt resolution/protection to bond holders, when needed, as time-value is of immense importance for bond market investors.  

Further, based on investor categorisation, the bond market is largely dominated by institutional investors. We will need to encourage retail participation and undertake measures that will help. Mutual funds are one vehicle that is successfully mobilising retail savings through various products. Attractiveness of such products can be enhanced to channelise more of the retail savings faster to increase investor base and deepen bond markets. 

Q) The government is considering tax benefits for investments in government securities to attract foreign investors. How much of a difference could this make to FPI participation in Indian bonds? 

Somani: The government's announcement to remove long-term capital gains tax and withholding tax for foreign portfolio investors in government securities provides a clear path for India's inclusion in major global benchmarks such as the Bloomberg Aggregate Index. While foreign investors typically prioritise underlying currency stability and yield differential over tax incentives, these tax benefits serve as a critical steppingstone. The initial impact will manifest as passive foreign portfolio investor (FPI) flows will be driven by index inclusion, which over time will catalyse broader trading activity from active global investors. 

MUST READ: India's mutual fund boom faces its biggest test: Can investors stay patient with near-zero returns?

Q) With Indian government bonds now part of major global indices, have foreign inflows met expectations? What is your outlook for FPI flows into debt over the next few years? 

Somani: Following India's inclusion in the JP Morgan index, passive foreign inflows arrived in line with India’s designated weightage. Though initially slow, the total foreign exposure has progressively scaled to closely match India's index weight. Furthermore, the removal of long-term capital gains and withholding taxes paves the way for imminent inclusion in the Bloomberg Aggregate Index. This next inclusion is projected to attract approximately $25 billion in fresh FPI flows over the coming years, depending on the exact size of the index at the time of entry. 

Q) How do Indian government bond yields compare with those of other emerging markets after adjusting for currency risk and taxation? Is India currently offering an attractive risk-reward proposition for global investors? 

Somani: On a headline basis, a 10-year Indian government bond yield ranges between 6.90% and 7.00%, compared to a 10-year US Treasury yield near 4.40% to 4.50%. INR hedging costs roughly 3% per annum. Thus, on a fully hedged basis the net return drops and this does not compare favourably to the US 10-year Treasury. Despite this, given the sharp currency depreciation seen over the last 3 to 6 months and recent central bank measures to attract foreign capital (such as concessional hedging rates for FCNR deposits and ECBs), the relative attractiveness of Indian bonds is likely to improve against other emerging markets. 

MUST READ: Axis Mutual Fund launches ‘Rozana SIP’; Investors can start with just Rs 10 a day

Q) Has liquidity in the banking system improved recently? What impact is this having on money market instruments and short-term bond yields? 

Somani: Over the last 3 to 6 months, banking system liquidity has fluctuated tightly between 0.5% and 1% of NDTL. Strong credit offtake outpaced deposit growth, straining system liquidity, and prompting the RBI to actively intervene via Open Market Operations (OMOs) and forex swaps. This structural tightness caused short-term bond yields and money market rates to flare up significantly, driving 1-year and 2-year instrument yields to highly attractive levels—trading roughly 200 to 250 basis points above the underlying repo rate. However, with recent RBI policy measures facilitating concessional hedging rates for FCNRB deposits and ECB borrowings, system liquidity is expected to improve, which should eventually pull short-term spreads back toward historical norms. 

Q) Money market funds have seen strong inflows in recent months. What is driving investors towards these funds, and do you see this trend continuing? 

Somani: The surge in money market fund inflows is driven by their strict mandate to invest only in instruments with maturities under one year, significantly containing volatility during market turbulence. Even during a highly volatile period marked by geopolitical tensions and currency pressure, monthly returns in this category never turned negative. Furthermore, these funds have consistently outperformed standard liquid funds by 25 to 50 basis points—translating to an attractive 75 to 125 basis points over the repo rate—making them one of a preferred choice for institutional capital. Given their open-ended structure, lack of exit loads and reliable predictability, they serve as an excellent short-term alternative to bank fixed deposits for horizons of over 2 to 3 months, ensuring that investor attention and category growth will persist.  

MUST READ: Looking for value-based investing? BSE's new Saatvik Index may have an answer

Q) For investors looking to allocate fresh capital today, what role should money markets and short-term debt funds play in their portfolios, and what probable returns can they realistically expect over the next 12 months? 

Somani: For fresh capital allocations, money market and short-term debt funds provide an excellent entry point offering high predictability and lower volatility. Instruments with 6-to-12-month and 1-to-2-year maturities are currently trading at highly elevated levels, sitting roughly 200 to 225 basis points above the repo rate. With the current repo rate at 5.25%, 6-to-12-month Certificate of Deposit (CD) rates are yielding a lucrative 7.25% to 7.50%, outclassing traditional bank fixed deposits while retaining total liquidity to switch assets if an emergency arises. Realistically, investors can expect a probable return of at least 150 to 200 basis points over prevailing overnight rates over the next 12 months. 

Q) Looking ahead, where do you see the biggest opportunities in Indian fixed income, and what should investors keep an eye on over the next 12-18 months? 

Somani: The immediate sweet spot in the fixed-income market lies in accrual funds and portfolios focused on short maturities ranging from three months to one year, which aims to optimise returns potential while minimise price volatility. Looking at the 12-to-18-month horizon, investors must closely monitor the impending monetary policy cycle. The combination of a weaker monsoon outlook and war-driven supply disruptions is expected to cause the RBI to hike interest rates to curb inflation. Once the rate hikes begin or are largely priced in, investors will get an ideal opportunity to pivot capital into long-duration funds to lock in higher yields and can aim to optimise total returns while minimising volatility across both the near and longer term. 

MUST READ: As NSE prepares for IPO, Zerodha's Nithin Kamath says it’s a ‘cash machine’. Here's why