India's Bond Market Faces Widening Yield Gap

India's Retail Investors Shun Equities, But Fixed Income Options Remain Elusive

Last Friday, we highlighted the growing disillusionment of Indian retail investors with the stock market, with only steadfast Systematic Investment Plan (SIP) investors holding on. However, even mutual fund schemes are facing an increasing number of SIP stoppages, largely due to the ongoing market volatility in West Asia.

As equities quiver under stress, a natural turn to fixed income is expected. When the return on capital declines due to a risky environment, capital tends to find a safer place to park itself. However, this is where institutional investors and retail investors in India part ways.

Buying bonds is not as convenient as buying stocks for the average Indian household. While it has become easier to buy a bond issued by the sovereign or a company online than it was 10 years ago, the process remains complicated. The capital markets regulator introduced registered online bond platform providers four years ago, and notable volumes have been notched up by a chunk of players. The Reserve Bank of India's retail direct scheme platform has shown a traded value of more than Rs 8,000 crore, a four-fold surge in a year, indicating that the retail investor is adding fixed income to their portfolio.

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However, when compared to the trillions worth of transactions in equities, the discomfort and doubts behind every retail investor's mind when it comes to fixed income become apparent. The difference lies in the level of understanding and product design. While the average retail investor may not match an institutional investor's heft in reading and understanding the equity market, bonds are complicated products by default that put off an investor from the get-go.

India is known for its high domestic savings pile, and it is a missed opportunity for the government to not have direct access to this when it comes knocking for funds in the bond market. The government has only accessed the household pool of money indirectly, through pension funds, banks, and mutual funds. Household savings get pooled by these intermediaries before finding their way into the bond market as institutional money.

In a way, this is efficient and reliable, but there are leakages as intermediaries decide based on their assessment of opportunities and may not align with the needs of the household all the time. Online bond platforms are changing that, but they have run into problems now and then when it comes to corporate bonds. The default complication of the product comes to haunt the investor here. Ananya Roy reminds us that the return of capital is more important in bonds than the return on capital. Credit risk and interest rate risks are something that should be understood always by investors.

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Until that happens, one must follow what institutional investors are up to in the bond market. Since the war, banks, fund houses, and primary dealers have all been selling bonds, but long-term investors such as provident funds, pension funds, and insurance firms have been big buyers. Which way is the retail investor leaning? That is a tough question to answer.

Unfortunately, the biggest institutional investor in the market has been the RBI, and its motivations are very different from that of other market participants, even retail. The RBI has bought the largest amount of bonds in its history in FY26 ostensibly to neutralise its own impact on domestic liquidity. The central bank will continue to be a participant this year too because of the compulsion on liquidity and foreign exchange. Foreign investors are unlikely to be big buyers, and a fund house manager gives a glimpse on what mutual funds should do through their debt schemes.

Institutional investors play a different game than retail investors in the markets. While the retail investor can certainly take some cues from them, the motivations are different, and what the investor needs is more incentives to go to the platforms to buy bonds. Are the regulators listening?