Corporate bonds gain favour as government securities' yields remain steady

Yield spreads widen as investors move to short-tenure corporate bonds; AA-rated issuers tap market amid low G-Sec supply and abundant banking system liquidity

Debt market investors are relocating their funds to shorter-tenure corporate bonds due to attractive yields as the same on government securities (G-Sec) remain steady.

 

The yield spread between AAA-rated five-year corporate bonds and G-Sec of similar maturity has widened by 22 basis points (bps) since the first week of June.

 

Since June 6, when the Reserve Bank of India (RBI) cut the policy repo rate by 50 bps, yields on the government bonds have remained steady while that on corporate bonds hardened.

 

“With government bond yields effectively locked in and having limited capital gain potential, the richer accrual opportunities in corporate bonds make them more appealing. There is clear interest in blending portfolios that target an overall yield of around 8 per cent,” said Ajay Manglunia, executive director at Capri Global Capital Ltd. “To achieve that, investors are allocating across both G-Sec and corporate bonds, with the latter offering better carry given the stagnant nature of sovereign yields,” he added. 

 

The growing investor interest in corporate bonds extends beyond top-rated issuances. Lower-rated corporate bonds, further down the credit spectrum, are offering yields approaching double digits, presenting attractive risk-adjusted returns for yield-seeking investors, said market participants. Even within the AA-rated segment, yields remain elevated at around 9 per cent.

 

Market participants further said that given abundant liquidity in the system, demand from banks, mutual funds (MFs), and insurance companies has surged for such bonds.

 

With limited supply of short-term G-Sec and the government preferring long-term issuances, corporate bond issuers, especially in the AA/AA+ category, are stepping in to meet the demand, flooding the market with short-tenor bonds. Consequently, while demand remains strong, oversupply has led to issuers being asked to offer higher yields — 75 per cent of the ₹8 trillion that the government will borrow in the first half of 2025-26 (H1FY26) will be through bonds of 10 years and above.

 

“There is a huge supply of corporate bonds now. Appetite is there because of abundant liquidity in the system. Also, there is not much credit demand. Either they are putting it in SDF (standing deposit facility) or in VRRR (variable rate reverse repo). So, half of the money that is left, they are trying to put it in mutual funds. That is why many mutual funds are becoming anchor investors,” said Venkatakrishnan Srinivasan, founder and managing partner of Rockfort Fincap LLP. 

 

While SDF is a financial tool that allows banks to deposit excess liquidity with the RBI without any security or collateral, VRRR is the rate at which the central bank borrows money from banks for a variable period of time, usually ranging from 14 days to 56 days.

 

The net liquidity in the banking system was in a surplus of ₹2.99 trillion on Tuesday, latest RBI data showed.

 

As long as system liquidity remains elevated, corporate bond supply, especially from private AA-rated issuers, is expected to stay robust.

 

At the same time, any decisive action by the RBI to drain durable liquidity could materially shift this balance, potentially dampening demand. The central bank is conducting VRRR auction of shorter tenure, which has not impacted durable liquidity.