The year 2025 began on a difficult note for the bond markets as liquidity was extremely tight. At the other end, there were expectations of interest rate cuts through the year.
The yields at the lower end and the upper end of the curve were somewhat similar, within 8 basis points of each other. Liquidity deficit kept the short- and medium-term rates high.
But things have swung around reasonably over the course of the year.
In the first quarter of CY25, the banking system liquidity was in deficit to the tune of ₹3 lakh crore.
Then the RBI swung into action with a series of actions over the course of the year.
First, it infused considerable liquidity to the tune of around ₹12 lakh crore over the course of the year via open market operations (OMOs), foreign currency swaps, four cash reserve ratio (CRR) cuts.
Importantly, interest rates (repo) were reduced by 125 basis points over the course of 2025, the highest in the world as most advanced economies reduced rates by 100 basis points.
In December 2025, a further ₹1 lakh crore was infused in two tranches and $5-billion forex swap for three years was carried out.
The infusion of liquidity had a varied effect on the yield curve.
The lower end of the curve saw yields fall sharply, while the upper end of the curve moved quite mildly.
While the 10-year g-sec yields saw a mere 17 basis points fall over the year, five-year and three-year G-Secs saw yields decrease by 40 basis points and 62 basis points, respectively.
In the case of one-year CPs (commercial papers) and CDs (certificates of deposits), the yield fall was at 100 basis points or more.
There was a steepening of the yield curve.
Not surprisingly, debt fund categories investing in the shorter end of the curve and those in the medium duration did quite well. Longer-duration and gilt funds underperformed heavily, given the modest yield moves at the upper end of the curve.
Steady rates and bond yields
Going into 2026, multiple factors are on a favourable trajectory for a stable macroeconomic scenario.
Domestically, inflation continues to be comfortable, with CPI only at 0.7 per cent in its recent print and projected to be just 2 per cent (by the RBI) for FY26, as food prices cool off significantly. Recent prints of WPI are in deflationary territory. In fact, if gold and silver are removed, even CPI is in negative terrain. Even core inflation is comfortable at 4-odd per cent.
The low base effect may result in inflation figures shooting up later in the year. But even so, the RBI projects inflation to be 3.9 per cent in Q1FY27 and 4 per cent in Q2FY27, well within its tolerance band.
The RBI’s recent actions (dollar-rupee swaps, forex sales etc.) reinforce the perception that the central bank would intervene when required to shore of the currency when volatility shoots up. So, rupee may not be a chief cause for concern in 2026.
On the fiscal front, the government continues to walk on the consolidation path and as with FY25, it could also cut back on infrastructure spends to shore up the fiscal deficit. Transitioning to the debt-to-GDP regime from FY27 would add to the clarity on this front.
The current account deficit, which came in at 1.3 per cent in Q2FY26 and projected to be 1.7 per cent in FY26, is still reasonably comfortable.
Growth has been healthy and RBI projections place FY26 GDP increase to be 7.4 per cent.
In all, the key sources of an inflation are all well under control for the foreseeable future, with GDP growth projections being quite robust.
Given this scenario, there may be limited scope for rate cuts in 2026, though some expectations are for a 25-basis point (bps) interest reduction.
Credit growth has come in at 12 per cent year on year as of December 15, while deposit growth was just 9.35 per cent. At lower rates, further reduction in deposit rates will strain already-low growth rates on this front. This further limits the scope for rate reduction, with the focus being on transmission of past rate cuts.
Another positive aspect would be addition of Indian bonds (Fully Accessible Route) in Bloomberg’s indices from April 2026, which would potentially lead to a $25-billion inflow.
Overall, there are positive triggers for a stable rate regime with no immediate push for yields to move rapidly in any direction.
From a macro and geopolitical perspective, a potential trade deal with US can help on the exports front strongly. Also, if Ukraine and Russia negotiations do reach a peaceful conclusion, there would be further reduction commodity prices.
What should investors do?
It is clear that the duration play, especially at the longer end of the yield curve, may not work as well as it did during the periods before rate cuts started as much of the bond rally in longer tenors played out in the anticipation period of 2024.
The focus for 2026 should primarily be on accruals, by investing in bonds or fixed income instruments with higher coupons or interest as the prospects of rate cuts may be low, if at all. In any case no more than a 25-bp cut anticipated for the foreseeable future. Duration play on bonds for capital appreciation is less likely to be available.
Though the medium duration part of the yield curve has played out well, there may be some scope for corporate bonds in the three-six-year range given the still-high yields to maturity available even in AAA bonds. Now, in mutual funds tracking medium duration and corporate bond categories, the yield to maturity (YTM) is healthy at more than 7.5 per cent, going up to almost 7.8 per cent.
At the lower end of the curve, there are options in the money market and short-duration categories for liquidity purposes. Funds in the category still have YTMs in excess of 7 per cent. In fact, in the fluctuating interest rate cycle over the past three years, quality money market and short-duration funds have recorded well in excess of 7 per cent returns consistently.
The following strategy may be useful for retail investors while allocating their money towards fixed-income instruments.
Now, the government has retained the rates for small saving instruments for the first quarter of CY26.
Investors can consider the RBI taxable bonds, which currently offer 8.05 per cent for a seven-year tenor. It offers 35 basis points more than the NSC (National Savings Certificate). The NSC itself can be a reasonably good avenue to park your surplus. Both these fixed income options have no upper limit for investing.
For liquidity and emergency funds, investors can consider short-duration/money market funds. ICICI Prudential Short Term and Nippon India Money Market can be considered by investors.
In case investors wish to go for the three-six-year portion of the yield curve can consider with mostly AAA-quality holdings can consider Axis Strategic Bond and ICICI Prudential Medium Term Bond that have a solid track record and offer YTMs in excess of 7.7 per cent.
Published on January 3, 2026
