Investors in India are expected to direct extra funds into short-term bonds, enhancing an already popular strategy in the country's debt market. This comes after the Reserve Bank of India surprised the market by injecting more cash into the banking system.

The unexpected move by the RBI to release 2.5 trillion rupees ($29 billion) starting September is likely to lead banks to prefer shorter-term securities over longer-dated ones, according to investors from UTI Asset Management Co. and PGIM India Asset Management.

Nitin Agarwal, head of India trading at Australia & New Zealand Banking Group Ltd., stated, "If credit growth is not picking up, the focus shifts to how to utilize the excess liquidity. In such a scenario, funds are likely to be invested in short-term bonds."

This year, India's yield curve has been steepening due to the RBI's significant liquidity injections, with short-term yields decreasing at a faster rate than longer-term ones. This trend has accelerated since the RBI's surprise shift to a neutral stance, reducing expectations for further easing and decreasing the attractiveness of longer-duration debt.

Some investors are now eyeing shorter-term corporate debt, noting the appealing yields currently available on such notes.

Puneet Pal, head of fixed income at PGIM Asset Management, mentioned, "We will adjust our portfolio towards corporate bonds, particularly in the 3-7 year segment where we see attractive spreads amidst ample liquidity."

HSBC Asset Management also favors corporate bonds in the 3-5 year range, offering spreads of 50-70 basis points over comparable government bonds. ITI Asset Management is interested in higher-rated bonds of state-run firms and shadow lenders.

However, not everyone is convinced that this strategy has more room for growth. Bandhan Asset Management believes further gains in shorter-dated bonds could be challenging.

Sandeep Yadav, head of fixed income at DSP Asset Managers Pvt., stated, "The yield curve is expected to stabilize, with potential steepening and flattening phases as market participants adjust their positions."

Currently, steepening remains a prevalent trend, with the spread between 10-year and 5-year benchmark yields widening to about 50 basis points - a three-year high.

As 10-year yields have increased, Power Finance Corporation Ltd., a state-run lender, has changed its fundraising plans by opting for shorter bonds maturing in approximately two years and five years, instead of bonds due in July 2035.

Nitin Agarwal from ANZ Banking Group mentioned, "While long-term bonds may not be overpriced, shorter-term bonds are likely to see their yields decline more clearly."

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