The advisable approach to debt funds is to match the portfolio maturity of the fund with your investment horizon.
Two key events last week – Trump’s 50 percent tariff on Indian imports and the Reserve Bank of India’s (RBI) status quo on repo rate – are bound to get retail investors thinking about their debt investment strategies.
RBI policy stance
In the recent policy review of the RBI Monetary Policy Committee (MPC), on August 6, 2025, interest rates were maintained at current levels. The broad expectation in the market was that RBI MPC would hold interest rates. Only a small section of the market expected reduction of repo rate from 5.50 percent to 5.25 percent. The takeaway from the MPC meeting is about the expectation on future policy action.
In the policy review meeting prior to this, held on June 6, 2025, they had changed stance from accommodative to neutral. The implication of neutral stance is, they would take rate action, either increase or decrease, only if required. Still, there was a mild expectation of a rate cut on August 6 as inflation for June 2025, announced in July 2025, was as low as 2.1 percent.
The rationale for holding interest rates was clear as the governor was going through the policy statement: inflation projection for the quarter April to June 2026 was announced at 4.9 percent, which was not there in the June policy review. This is on the higher side, as the target is 4 percent inflation. Inflation for 2025-26 is expected to be 3.1 percent, which is on the lower side. However, this is creating a low base, which would contribute to higher inflation in 2026-27. RBI MPC looks at the projections for their interest rate decisions, hence this is relevant.
Post the policy review on August 6, 2025, expectation of further rate cut is dim. The reason is, RBI’s inflation projection for the quarter January to March 2026 is 4.4 percent, and combined with 4.9 percent for the next quarter, RBI is looking at 4.65 percent in the first half of 2026.
Steeper US tariffs
The impact of the high tariffs imposed by USA is of course negative on our exports, current account and currency, though it may not be as severe as it seems now. US is our largest export destination, accounting for 18 percent of our exports. Tariffs being lower on certain other countries, our exporters are disadvantaged.
Over a period of time, through negotiations, a lower tariff may be worked out. Many countries, stung by higher US tariffs, are in touch with each other to increase trade. India also is doing the same. Hence the 82 percent share, the non-US component, may improve going forward.
Exports contribute to GDP growth. Lower exports would shave off a part of our GDP growth. To what extent is anyone’s call; broadly, economists are looking at 20 to 40 basis points (0.2 to 0.4 percent) of GDP growth in the current financial year. Lower GDP growth is bad for equity markets, but positive for the bond market. If GDP growth is lower, it is reason for the RBI to support growth through lower interest rates. However, it is a mild positive, as it is more for the government to help exporters through various measures and not just up to the RBI.
Focus on your goals
Probability of gains in debt funds driven by interest rates coming down is limited. The MPC has already cut repo rate by 1 percentage point, which has been factored into the price. Further rate cut is not ruled out, but probability is on the lower side. Hence, if an investor is exposed to a long maturity fund only for the sake of capital gains, it is advisable to gradually move out. There is no hurry, but it should be done in say six months or so.
The advisable approach to debt funds, on a ballpark basis, is to match the portfolio maturity of the fund with your investment horizon. The logic is, debt funds earn from accruals i.e. the interest on the securities in the portfolio and mark-to-market – movement of bond prices in the secondary market. The mark-to-market component can be favourable or adverse, depending on interest rate movement. Even if bond prices were to go down in the secondary market, if you remain invested for an adequate period of time, the accruals take care of it.
If your horizon is, say, one or two months, for the liquid component of your portfolio, liquid funds of mutual funds are appropriate. If your horizon is say three to four years, then corporate bond funds are appropriate. Funds with a long maturity, such as government security funds, are advisable over a long horizon, say 10 years.
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