Fixed deposit yields dip after RBI repo rate cut - should investors go for bonds despite hidden risks?

As the Reserve Bank of India slashed repo rates last week,  fixed deposit yields are set to slide in the near future. In such a situation, many conservative savers are drawn towards exploring bonds for better returns amid falling deposit rates. Yet this shift demands caution—bonds introduce risks absent in FDs, like credit defaults and price volatility from rate changes.

Bond investing is essentially lending money to issuers, governments, PSUs, or corporations, for a set period. You receive periodic interest (coupon payments) and your principal back at maturity. Amar Ranu, Head of Investment Products & Insights at Anand Rathi Shares and Stock Brokers, explains that face value represents your guaranteed repayment, while coupon rates, fixed or floating, determine annual income. Fixed coupons stay constant; floating ones adjust with market rates, offering protection against rises.

The issuer's profile shapes risk: sovereign-backed government bonds are safest, PSUs like strong corporates follow, while private firms vary by financial health. Ratings from CRISIL, CARE, or ICRA guide choices, AAA signals low default risk but modest yields; lower grades promise more but heighten danger.

Key risks

Credit risk tops concerns: unlike FDs with DICGC insurance up to Rs 5 lakh, corporate bonds rely solely on issuer solvency. Interest-rate risk affects prices inversely—rising rates devalue existing bonds, hitting long-maturity ones hardest. Inflation erodes real returns if yields trail price rises, turning positive nominal gains negative. Liquidity risk plagues thinly traded bonds, complicating quick sales.

Ranu stresses maturity's role: short-term bonds (under 3 years) minimize rate sensitivity for stability; longer ones boost yields but amplify volatility. Post-RBI cut to 6.25%, bond prices may rise short-term, but future hikes could reverse this.

Government, corporate, municipal bonds

Government bonds excel in safety with near-zero default odds, suiting capital preservation. Corporate bonds tempt with 1-2% higher yields, compensating for business risks. Municipal bonds shine via tax-free interest under Section 10(15)(iv)(h) at 8-9%, funding infrastructure while netting superior post-tax returns over taxable FDs.

Ranu notes benefits like predictable income and portfolio ballast during equity dips. They preserve capital better than stocks, ideal for retirees seeking stability.

Bond investment and rate cuts

Retail investors are gravitating toward bonds for two primary reasons, according to experts. Many individuals now prefer a steady monthly income—often due to career shifts or the need for reliable cash flow—and bonds are well-suited to deliver that stability. They also add meaningful diversification to portfolios.

The second driver is the rise in bond yields and the ease of investing through digital platforms. With returns now outperforming fixed deposits (FDs) and competing closely with debt mutual funds, bonds have become far more appealing.

High-quality corporate and government bonds generally offer 7–9% returns, while select higher-risk NBFC bonds can yield 10–12 percent. Meanwhile, FD rates have come down to around 5–6% with the interest-rate cycle softening in recent months.

As rates continue to decline, investors can go for G-Secs, state development loans (SDLs), and corporate bonds based on their risk levels and income expectations. G-Secs, in particular, are ideal for conservative investors prioritising safety and capital protection, especially since they typically gain when yields fall.

Buying bonds

Buy bonds via banks, brokers, online platforms, or new issues. Debt mutual funds simplify access, pooling for diversification and liquidity. Ladder maturities—spread across durations—to manage rate shifts. Prioritise AAA/AA ratings, blend fixed/floating for inflation hedges.

Ranu advises: "Balance risk-reward via ratings and diversification." With FD rates dipping below 7%, bonds offer 7.5-9% pre-tax for qualified investors, but demand due diligence. Inflation at 4-5% underscores real-return focus.