India's corporate bond market is experiencing weaker demand as interest rates rise, according to fund managers. This shift is attributed to several factors, including investors booking profits, rising bond yields, and concerns about the economic impact of potential US tariffs.

Mutual funds focused on corporate bonds saw their first outflows of the financial year in August, with corporate bond, credit risk, and banking and PSU debt mutual fund schemes experiencing combined outflows of 18.7 billion rupees ($211.8 million). This is a sharp reversal from the net inflows of 237 billion rupees recorded in the first four months of the fiscal year, which began in April.

Fund managers suggest that the outflows in August are largely due to investors taking profits as yields rise. Rising interest rates in India and globally, along with widening corporate bond spreads, have led to underperformance in bond funds. The expectation of further domestic rate cuts has also faded, prompting redemptions as investors secure gains. Some anticipate these outflows will continue into September, posing challenges for fund managers in maintaining investor confidence. Investors have enjoyed reasonably high returns in corporate bond categories over the past two years, but with monetary easing largely behind us, some are choosing to book profits.

The prices and yields of bonds move in opposite directions, so rising yields indicate falling bond prices, which typically signals weak demand or an oversupply. Demand from traditional buyers like banks, insurers, pension funds, and foreign portfolio investors (FPIs) isn't keeping pace with the increasing supply of long-term bonds issued by the government and states. FPIs have been net sellers, with debt outflows reaching approximately $2.3 billion in April 2025, marking the worst levels since the COVID-19 pandemic. A significant factor is the India–US 10-year spread, which reflects the premium investors demand to hold Indian bonds, considered riskier than US Treasuries. The spread has collapsed to around 200 basis points, its lowest since 2004, making American treasuries relatively more appealing. Confusion regarding the Reserve Bank of India's (RBI) rate policy has also amplified the problem.

While bond yields typically decrease amid low inflation and interest rate cuts, experts note they have been increasing due to concerns over tax collections, the fiscal deficit, and the potential impact of US tariffs. The RBI's shift from an 'accommodative' to 'neutral' stance, signaling a rate pause after three rounds of interest rate cuts, has also contributed to the rise in bond yields.

Despite these challenges, some experts believe that India's bond market is gaining strength from the government's fiscal prudence and its upcoming transition to a debt-to-GDP framework. This is expected to create confidence and stability for long-term investors, even with global yield pressures and trade tensions.