Why Gilt Fund NAVs Fell Despite RBI’s 0.5% Rate Cut?

Why Gilt Fund NAV fall after RBI rate cut? Understand why NAVs dropped despite a 0.5% repo rate cut, with insights on yields, RBI policy, and market reactions.

The Reserve Bank of India (RBI) recently reduced the repo rate by 0.50%, marking the third consecutive rate cut. Naturally, many debt fund investors—especially those invested in Gilt Funds and Gilt Constant Maturity Funds—expected a rally in NAVs. After all, bond prices and interest rates generally move in opposite directions. When interest rates fall, bond prices rise, leading to capital gains, especially in long-duration bonds like those held by gilt funds.

But what surprised many investors was the exact opposite: on the day the RBI announced the rate cut, the NAVs of constant maturity gilt funds actually fell.

This anomaly has created confusion and concern among investors. In this article, we’ll delve deeper into this counterintuitive outcome, analyze what really drives gilt fund NAVs, and understand the broader macro factors influencing the debt market—especially why a rate cut doesn’t always mean rising gilt fund NAVs.

Why Gilt Fund NAVs Fell Despite RBI’s 0.5% Rate Cut?

What Are Gilt and Gilt Constant Maturity Funds?

Before diving into the reasons, let’s clarify what gilt funds and constant maturity gilt funds are:

• Gilt Funds invest primarily in government securities (G-Secs) of varying maturities (minimum 80% in G-secs, across maturity). They are zero-credit-risk products, meaning the principal and interest are backed by the Government of India.
• Gilt Constant Maturity Funds are a subtype of gilt funds that only invest in G-Secs with a constant maturity of around 10 years (minimum 80% in G-secs, across maturity), as mandated by SEBI. These funds are highly sensitive to interest rate changes due to their long duration.

Because of this sensitivity, they are typically expected to perform very well during a falling interest rate cycle.

The General Rule: Interest Rates vs Bond Prices

When the repo rate—the rate at which the RBI lends to banks—falls, it signals an easing monetary policy. This typically results in a fall in yields across the bond market and a rise in bond prices.

Here’s why:

• Bonds issued earlier (at higher interest rates) become more attractive.
• New bonds will be issued at lower yields, making existing high-yield bonds more valuable.
• This pushes prices of long-duration bonds (like 10-year G-Secs) higher.

So, NAVs of gilt funds, especially constant maturity funds, usually rise when rates fall. Then why didn’t this happen recently?

What Actually Happened on the Day of the Rate Cut?

Let’s analyze the market behavior on the Friday when the RBI announced the 50 basis points cut.

Bond Yields Spiked Instead of Falling

Despite the rate cut, the 10-year G-Sec yield rose by around 5–7 basis points. This means bond prices fell, since yield and price are inversely related.

This is the primary reason why NAVs of constant maturity gilt funds fell on that day. These funds are directly linked to the 10-year G-Sec, so any spike in the yield translates into a fall in NAV.

But why did yields spike on a day when they were supposed to fall?

Deeper Analysis: 5 Key Reasons for the Gilt Fund NAV Fall

1. Bond Market Anticipation Was Already Ahead

The bond market is forward-looking. It had already priced in the rate cut well in advance. When the actual announcement was made, there was no surprise factor.

In fact, many traders had already booked gains on expectations of the cut and started selling to lock in profits, leading to selling pressure and rising yields.

2. Dovish Rate Cut, But Hawkish Commentary

The RBI’s monetary policy statement matters as much as the rate cut itself.

While the rate cut was dovish, the accompanying commentary was neutral to slightly hawkish, which spooked the bond market. Here’s what made investors nervous:

• No clear future guidance about further rate cuts.
• Caution regarding inflationary risks.
• Increased emphasis on fiscal concerns, which could lead to higher government borrowing.

These concerns reduced expectations of an extended easing cycle, thereby causing yields to rise.

3. RBI’s Silence on Open Market Operations (OMOs)

The bond market was expecting the RBI to announce Open Market Operations (OMOs) to absorb excess supply of government bonds.

But the RBI didn’t mention any new OMO calendar.

This disappointed the market. Without RBI support, there’s a risk of bond oversupply, which leads to falling prices and rising yields.

In a simple way to explain, when the government borrows money (by issuing bonds), there’s a lot of supply of bonds in the market. If too many bonds are available and not enough buyers, bond prices fall and yields go up. This is bad news for gilt funds, as their NAV drops when bond prices fall.

To prevent this, the RBI sometimes steps in and buys bonds from the market through something called Open Market Operations (OMOs). This is like a big buyer entering a market to support prices.

But in this case, although the RBI cut the repo rate, it didn’t say anything about buying bonds through OMOs. This made investors worry:

“If the RBI doesn’t step in, who will buy all these bonds? Prices might fall!”

So, due to this lack of support from RBI, the bond market reacted negatively, bond prices fell, and as a result, gilt fund NAVs dropped.

4. Concerns Over Fiscal Deficit and Borrowing

The government’s borrowing program and fiscal health play a crucial role in bond markets.

Due to rising subsidies, welfare schemes, and tax revenue shortfalls, the market expects a higher fiscal deficit, which means more bond supply.

More supply leads to:

• Lower prices
• Higher yields
• Negative impact on gilt NAVs

Remember, constant maturity gilt funds invest heavily in 10-year bonds. So, any indication that the government will flood the market with bonds causes their prices to fall.

5. Global Cues and U.S. Bond Yields

Indian bond markets are not immune to global interest rate trends.

Around the same time, U.S. Treasury yields were rising due to:

• Strong economic data
• Reduced expectations of U.S. Fed rate cuts

Foreign investors (FIIs), who hold significant portions of Indian bonds, often react to global movements. Rising U.S. yields reduce the attractiveness of Indian G-Secs, leading to FII outflows, selling pressure, and rising yields domestically.

Should Investors Worry About Gilt Fund NAV Fall?

Not necessarily. Here’s why:

• Do note that Gilt Funds are highly volatile in nature (even though they invest in government bonds). Hence, explore Gilt Funds only for your long term goals. Hence, never use Gilt Funds by looking at past returns for your short term goals (or even for medium term goals).
• Volatility is normal in debt markets, especially in long-duration products like constant maturity gilt funds.
• Even though short-term NAVs may fall, the long-term return potential remains intact, especially if the interest rate cycle continues to ease gradually.
• Gilt constant maturity funds are suitable for investors with a time horizon of more than 5–7 years (Gilt Constant maturity funds are best suitable if your goals are mothan 10 years away), who can tolerate interim volatility.

What Should You Do Now?

If You’re Already Invested:

• Don’t panic due to short-term NAV movements.
• Stay invested if your time horizon is long and you’re aware of the volatility.
• Constant maturity gilt funds are not for short-term parking or for conservative investors.

If You’re Planning to Invest:

• Be clear that duration risk is high in these funds.
• These funds work best when interest rates are expected to fall steadily over time.
• Consider entering in phases (SIP/STP) rather than lump sum, especially during volatile times.

Conclusion

The fall in gilt fund NAVs, despite the RBI’s rate cut, may seem confusing, but it’s a classic example of how market expectations, fiscal concerns, and global cues can override straightforward monetary policy logic.

While the repo rate is a key driver, the bond market reacts to a range of factors—RBI’s guidance, future rate outlook, supply of bonds, and global interest rates.

As always, debt fund investing—especially in long-duration categories like gilt constant maturity—requires a solid understanding of risk, patience, and a long-term approach.