How Rate Cut Affects Debt Funds

It is recommended you match your investment horizon with the portfolio maturity. When there is adverse volatility, the accrual over your holding period will take care of it

- BY JOYDEEP SEN

For some time now, the market was expecting a rate cut from the Reserve Bank of India (RBI). Finally, on February 7, 2025, the RBI cut the repo rate by 25 basis points (bps) from 6.50 per cent to 6.25 per cent. This is a signal for interest rates across the system to decline. Based on this expectation, longer duration funds have been recommended.

The rationale is: given that the interest rate and bond prices move inversely, the longer the duration of the fund, the higher will be the gains.

View Going Forward

The expectation going forward is that RBI would execute another 25 bps cut, or at most two more cuts of 25 bps each, at an appropriate time. This cycle is going to be a shallow rate cut cycle, as RBI has to take care of inflation as well.

Markets, however, react in anticipation. The 10-year government bond yield eased from 7.2 per cent on January 1, 2024 to 6.75 per cent on February 6, 2025, even before any rate cut. As and when market starts anticipating the next rate cut, the yield level on bonds would ease further. That is because there is further scope for gaining from interest rates coming down. However, it has to be seen in context.

How Debt Funds Work