A former banker now wants you to buy more debt mutual funds

At the heart of this is a former banker who spent nearly four decades at India’s largest lender State Bank of India’s (SBI) and rues the lack of liquidity in the bond market. Venkat Nageswar Chalasani, the chief executive of industry body Association of Mutual Funds in India, or Amfi, believes people need to be made aware of investing in debt products, a move that will improve the market liquidity, while allowing people stable returns.

“See, (for) any market to develop the most important thing is the liquidity has to be there. Today, the equity market is so great because I have a scrip and I can go and sell as there is a buyer in the market,” Chalasani, who took over as the chief executive in November 2023, said in an interview.

Set up in August 1995, Amfi is a non-profit industry body of mutual funds.

Low retail participation in bonds

Selling bonds to retail investors has not been an easy task, given the complexities around how the bond market operates. For starters, bond prices and yields move in opposite directions. There have been attempts to make buying of bonds more attractive.

For instance, the Reserve Bank of India (RBI) launched its retail direct platform in November 2021, allowing individuals to directly buy government bonds. It has also now allowed systematic investment plan or SIP in certain sovereign debt papers, making it easier to invest. There were 295,228 accounts on the RBI platform as on 18 August, up from 163,097 a year ago. However, investor holdings have only grown 11% to ₹2,441.2 crore as on 18 August, per RBI data.

That apart, online bond platforms licensed by markets regulator Securities and Exchange Board of India (Sebi) allow investors to buy bonds. There are 24 online bond platforms registered with the National Stock Exchange, but data on investor holdings is not available.

“So liquidity is something that is extremely important for us to develop the fixed income space and that’s what the RBI is working on, the Sebi is working on. Trust me, the markets can develop in this space by bringing more retail investors,” said Chalasani.

Tax changes hurt debt funds

The former banker believes that the way to bring in more liquidity is getting more retail investors through the mutual fund space, instead of scouting such investments only through the direct route.

“We are working with the government of India on this,” he said. “The government has withdrawn the tax benefits on the fixed income side. This used to be a big attraction for the people to come into the space and that was withdrawn.”

Until three years ago, debt mutual funds enjoyed a significant tax edge over fixed deposits. If investors held debt funds for more than three years, their gains were classified as long-term capital gains (LTCG) and taxed at 20% with the benefit of indexation, which adjusted the purchase price for inflation.

“This arbitrage made debt funds an attractive alternative to bank deposits, drawing substantial money from retail and HNI investors,” said Amit Sahita, director, Fincode Advisory Services Pvt. Ltd.

However, about three years ago, the government removed this advantage. Now, capital gains from debt mutual funds are taxed at the investor’s slab rate, just like fixed deposits, with no indexation benefit. “This change pushed many retail investors out of debt funds, with the segment today being dominated largely by corporates, banks, and NBFCs using them for treasury management and short-term parking of cash,” he added.

Also, the relative attractiveness of the equity segment has also kept retail investors away from meaningful debt allocations, said Suranjana Borthakur, head of distribution and strategic alliances at Mirae Asset Investment Managers.

In the mutual fund industry, inflows in equity schemes have dwarfed investments in debt schemes. In FY25, equity schemes saw net inflows of ₹4.17 trillion, compared to ₹1.38 trillion in debt mutual funds, showed data from AMFI’s annual report. The trend remains unchanged even when looked at in terms of the number of investor accounts in each category. The number of folios in equity schemes stood at 163.8 million as of end-March, as against 6.9 million in debt schemes.

A major chunk (68%) of India’s ₹65.7 trillion mutual fund assets under management was either in equity and debt schemes in FY25. Between the two categories, equity schemes accounted for 66% of the assets.

Shift from deposits to markets

Meanwhile, Chalasani’s push comes at a time when bank deposit rates — a comparable fixed income product — have hit historic lows on account of outsized repo rate cuts. Savings deposit rates have plunged to a 25-year low and fixed deposit rates have seen steep cuts. Mint reported in June that large banks like State Bank of India, HDFC Bank and ICICI Bank lowered their savings deposit rates to 2.5-2.75%, the lowest since RBI began collecting such data in FY01.

Term deposit rates are no outlier. The weighted average term deposit rate of banks on fresh deposits stood at 5.75% in June, down 74 basis points (bps) from the same period last year, per data from RBI.

There is a growing debate over how households are increasingly channeling their savings into markets, instead of parking them in bank deposits. Bankers have emphasised that this shift does not change overall system liquidity, since the money ultimately remains within the banking system as deposits. But what changes is the composition—with savings moving from retail deposits to corporate deposits—where interest rates are higher.

“People are looking at not just savings, not just the fixed deposits, but are looking to get much more, be a part of the growth story of the country,” said Chalasani. “They are realizing that the gains can come only from investments and that is why there is a movement of the retail investment behavior from the banking sector into the capital markets.”