What the budget means for debt investors 

With the Finance Minister’s announcement on income tax hogging investor attention post-Budget, its implications for fixed income investors have flown under the radar. Here is how the proposals impact debt investors. 

Had the bond markets been open on Saturday, it is likely that they would have cheered the Budget. The Central government is the biggest actor in the Indian bond market. Government security yields set the floor for all other instruments. Three sets of numbers in the 2026 budget pave the way for a decline in market yields over the medium term and are bullish for bond prices. 

• Tight deficit target: Since it came to power, the NDA has built a reputation for achievable Budget math and sticking to its fiscal deficit targets. The 2026 budget reinforced this reputation. Whether the Government would manage to achieve its fiscal deficit target of 4.9% for FY25 was in some doubt, after nominal GDP growth for the year was downgraded to 9.7% (by the First Advance Estimates of the CSO) from the 10.5% assumed in budget 2024 calculations. But it managed to not just meet the target but slightly undershoot it, with the fiscal deficit estimated at 4.8% for FY25. For FY26, the government had earlier indicated that the fiscal deficit would be brought down to 4.6%. It has now set its deficit target a tad lower at 4.4%.  Will the government achieve this target? A break-down of budget math suggests that it can. The 4.4% fiscal deficit target is based on the assumptions laid down in the table below. 
  
  The nominal GDP growth assumption of 10.1% looks achievable, as a real GDP growth of 6% and average inflation of 4.1% appear well within reach next year. Growth in corporate tax revenues and GST are broadly in line with this nominal GDP growth. The growth of 14.3% assumed for personal income tax alone seems a little ambitious, especially as income tax rates have been slashed across the board and the rebate raised sharply. However, tax cuts can spur improved compliance and actual growth in personal income tax collections post-Covid has been at 25%. Even allowing for some under-achievement on this number, it can be made up by better GDP growth, higher inflation, or a tighter rein on expenses. 

• Flat borrowings: With the fiscal deficit tightened considerably, the Centre expects to curtail its market borrowings to Rs 11.53 lakh crore in FY26 against Rs 11.62 lakh crore in FY25(RE). With this, both the fiscal deficit and Centre’s market borrowings would have moderated substantially from Covid times. In the Covid year of FY21, the fiscal deficit shot up to 9.5%, entailing market borrowings of Rs 12.73 lakh crore.  
  
  Moderating government borrowings are bullish for bond markets on two counts. One, in an expanding economy, a lower supply of government bonds opens up room for private entities and financial institutions to tap bond markets to raise funds. It also allows banks to expand credit instead of deploying their scarce resources to buy up gilts. 
  
  Two, given that the Government of India is the largest (and safest) borrower in the market, lower supply of gilts in the year ahead should lead to a fall not just in gilt yields, but also in market interest rates across-the-board. Yields on medium and long-dated bonds are most affected by the government borrowing calendar. 
  
  For overnight and short-term bonds, the main driver of yields is liquidity. After maintaining a tight grip on liquidity conditions until December 2024, RBI has open the taps of liquidity in January 2025 - with Open Market Operations, swaps and repos. This has already moderated short-term call money, commercial paper and overnight rates to 6.5-6.6%. 
  
• Targeting lower debt: Having achieved the fiscal deficit targets it set out just after Covid, the Centre is now looking to shift its goalpost from fiscal deficit targets to lowering its debt pile. A fiscal policy document accompanying the latest budget has stated that the plan is to steadily lower the Central government debt-to-GDP ratio, from the current 57.1% to about 50% by 2031. Progress on this front can win India a sovereign rating upgrade and drive a structural moderation in government bond yields. 
  
  It is thanks to these changes perhaps that the yield on the 10-year gilt hovered at 6.69% on February 3, as the bond markets re-opened for the first time post-budget. This compares to 6.78% just before the Budget.  
  
  However, for investors looking to bet on long-term bonds, the wild card factor that could postpone the decline in yields is the possibility of FPI pullouts. After the inclusion of Indian gilts in JP Morgan benchmarks last year, India did receive a flood of FPI flows into g-secs. But since October, the spike in US market yields and uncertainty about Trump policies has led to FPIs going into risk-off mode and engaging in sporadic pullouts.  
  
  The outflows so far are not very large, with outflows of $1.1 billion since October compared to gross inflows of $19 billion over the year 2024. But with uncertainty about the timing of domestic rate cuts and volatile FPI flows triggering two-way moves in market yields, betting on long duration bonds or funds can be an uncertain source of returns in the year ahead.  
  
  Therefore, we see no reason to change our view that tactical investors should move from duration to accrual strategies for returns in 2025.
  
  Read our January 2025 debt outlook for the detailed view on rates 

Strategy 

In terms of debt strategy, investors with short term surpluses should lock into FDs or funds with 2-3 year maturity to reduce reinvestment risk as rates fall. Those with medium horizons of 3-5 years can consider AAA bonds and debt funds from our recommendations. Investors with 5 year plus horizons can stay with the combination of gilt and other funds we have recommended for long term investors in Prime Funds, while bracing for higher short-term swings in returns.