In last week’s Big Story, we talked about why rising bond yields (and central banks hiking rates) globally, could represent a regime change for equity investors. As global interest rates climb after a prolonged phase of repression, investors may need to lower their return expectations from equities, at least at the market level. But there’s a positive side to this yield spike too — it opens up better return opportunities for debt investors.

In India, interest rates never went to zero. Therefore, the rise in yields poses less of a shock than in say, the US or Japan. However, with the Monetary Policy Committee (MPC) restarting a rate hike cycle after a four-year gap, Indian debt investors may need to recalibrate their strategies to benefit from higher rates. To know what kind of bonds to own now, you need to gauge the direction of interest rates and the quantum of the change.

How market rates behaved

Today, whether you consider long-term interest rates or short-term, the direction is clearly up.

Long-term bond yields in India are pegged to the 10-year government security, which acts as the floor for long-term borrowing costs. After the Iran war broke out in February 2026 and oil prices surged, Indian bond markets worried about rising subsidies forcing the Central government to overshoot its deficit target. Therefore, the yield on longer-tenure Central government securities spiked first. Between January and April 2026, the yield on the 10-year G-Sec (government bond) rose from 6.6 per cent to 6.9 per cent. During this period, inflation remained low and there was no talk of policy rate hikes; so short-term interest rates stayed put.

With State governments on a borrowing binge, yields on SDLs (State government loans) spiked more, from 7.5 per cent to 7.9 per cent. Corporate bonds, which usually trade at a spread over G-Secs saw their yields increase. They rose from 7 per cent to 7.5 per cent for one-year AAA-rated bonds and 7.25 per cent to 7.6 per cent for three-year AAA-rated bonds. However, a frugal budget, which stayed with a 4.3 per cent fiscal deficit target in March and fuel price hikes in May, thereafter allayed fears about the deficit overshooting. Therefore, between April and October 2026, India’s 10-year government bond yields have risen only marginally from 6.9 per cent to 7.25 per cent.

However, yields on short-term bonds have played catch-up in this period. In recent months, it has become quite clear that a quick resolution to the Iran war is unlikely. Elevated energy prices and the long-lasting El Nino, have thus put upward pressure on domestic inflation, propping up CPI (consumer price index) inflation from 3.4 per cent in March to 4.8 per cent by August. This prompted bond markets to begin pricing in rate hikes by the Monetary Policy Committee (MPC), with yields on 91-day to 364-day treasury bills rising from 5.3-5.6 per cent in April to 5.5-6.2 per cent now.

This week, the MPC met the market’s expectations by raising the repo rate by 25 basis points to 5.5 per cent. It also indicated that further rate hikes were in the offing, by talking of “calibrated tightening”.

What’s priced in

The above analysis shows that the direction of rates is pretty clear today. But how much will rates rise from here and how much of this is already priced into market yields? This is an important question because bond markets, like stock markets, price in events much before they happen.

On the first question, it is too early for a definitive answer. In the post-Covid rate hiking cycle that lasted from 2022 to 2023, the MPC hiked rates from 4 per cent to 6.5 per cent (250 basis points). In the extended cycle from 2010 to 2014, it hiked rates from 5 per cent all the way to 8 per cent, a 300-basis point hike. However, there have been shallower cycles too like 2017-18 when rates went up just 50 basis points from 6 per cent to 6.5 per cent. The quantum of hikes this time around will depend on incoming data on inflation, growth and capital flows. But it would be good to brace for an extended cycle.

On the second question of what the market is pricing in, the bond market seems to be pricing in another 70-75 basis points in rate hikes. One, the 364-day Treasury bill trades at about 6.28 per cent now, which is 78 basis points above the repo rate; T-bills yields have usually traded pretty close to the repo rate. Two, the 10-year G-Sec yield, at 7.23 per cent, is now 173 basis points above the repo rate. The average spread between the 10-year G-Sec and the repo has historically hovered at 80-100 basis points. This suggests that the additional 73 basis points is the market expectation for further rate increases.

Your debt strategy

This means three things for your debt strategy:

* With rate hikes just beginning, it may be risky to lock into bonds or debt mutual funds with long tenures (five years plus). Should market yields continue to shoot up or rate hikes go on for long, you can lose money by buying into long-duration bonds or debt funds today. In the past 15 years or so, 10-year G-Sec yields in India have topped out close to 8 per cent. Therefore, it would be good to wait for levels of 7.5-8 per cent on the 10-year G-Sec before considering long-duration bonds or debt funds. If you have surpluses to deploy now, it is safer today to invest them in bonds or debt funds with tenures of upto three years. This way, you can benefit from further rate hikes for as long as this cycle continues.

* Among three-year instruments, high-quality corporate bonds look attractive at yields of over 8 per cent. One- year and three-year AAA corporate bonds now trade at spreads of 142 and 125 basis points respectively over similar maturity G-Secs, which is high from a historical perspective. This makes such bonds a good buy. Currently, bonds from M&M Financial, Tata Capital, rated AAA and maturing in 2029, offer yields of about 8.1 per cent. PSU bonds from IRFC, HUDCO and SIDBI, maturing in 2029, offer about 7.65-7.8 per cent.

* While yields on G-Secs and corporate bonds are already factoring in the rise in policy rates, the fixed deposit market is yet to catch up. Large banks like SBI and ICICI still offer just 6.3-6.5 per cent for three-year deposits. Small finance banks, which traditionally offer the best FD deals, offer only 7.5-8 per cent, that too for special windows. Highly-rated NBFCs like Sundaram Finance and Bajaj Finance offer 7.25-7.75 per cent on three-year deposits. This could be due to banks enjoying comfortable liquidity after their FCNR (B) flows.

Debt investors fishing for higher returns today should thus stick to corporate bonds or debt mutual funds, opting for the shortest tenure possible within three years.

The author is a Contributing Editor

Published on October 10, 2026