FY26 Budget: A catalyst for infrastructure growth, market reform

As can be seen, bond markets play an important role in financing large infrastructure projects. Moreover, exposure to bonds also helps savers diversify from their equity or real estate exposure towards a relatively predictable, liquid and stable asset stream.

In India, the household sector is the net lender that generates surplus savings relative to its income, which it lends to the government and the corporate sector who are usually the borrowers.

In the last few years, retail investors have been looking at financial markets in greater numbers to grow their wealth.

Demat accounts have grown to over 18.5 crore at the end of December 2024 from 4.1 crore at the end of FY20 (Source: SEBI, NSDL, CDSL).

At the same time, retail investments in equity mutual funds have also grown by a healthy 39.7 percent CAGR — from Rs 3.73 trillion in March 2020 to Rs 16.8 trillion in September 2024 (source: AMFI). This has helped the mutual fund industry grow from Rs 24.7 lakh crore in March 2020 to Rs 55 lakh crore in March 2024.

The strong retail participation in equities has helped investors achieve investment goals, opened up avenues for domestic companies to tap growth capital and provided a strong counterbalance to capital markets during FPI outflows. However, fixed income funds especially, duration mutual funds that typically maintain a duration of more than one year and can subscribe to longer-term bonds, have seen a reduction in their AUM from March 2021.

Lower interest rates during the coronavirus pandemic (2020-2022) were possibly one of the reasons for reduced participation in fixed income. However, investments in fixed income have been muted despite the post-pandemic rise in interest rates. Investors have stayed away due to changes in taxation of debt mutual funds.

India’s vast investment needs call for actively promoting corporate bonds to investors. Duration funds as a percent of GDP comprise less than 2 percent for India (Source: UTI MF research) compared to 17 percent for the US (Source: IIFA). Hence, there is a strong need to align taxation for fixed income mutual funds to direct investment in debentures.

Fixed income mutual funds can offer a diversified and relatively liquid portfolio of assets compared to direct investment in bonds. A professionally managed fund may be better off in managing the credit and interest rate risk on these investments.

Given the lack of depth and information asymmetry in bond markets, investors may benefit by investing in fixed income mutual funds till sufficient awareness is created among investors for fixed income.

The mutual fund industry has popularised and educated investors on disciplined equity investing, benefiting both investors and capital seekers. Mutual funds have helped investors take exposure to equities in a transparent, convenient and cost-effective manner. The same could be replicated in fixed income, albeit with the right support.

Given the need to create high-quality physical and social infrastructure, it is crucial to provide policy support to ensure that the institutional architecture of financial intermediation is more diversified.

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