As India aspires to build a resilient, diversified, and globally competitive financial system, the role of a deep and vibrant bond market cannot be overstated. This vision is underscored by NITI Aayog's recent report on 'Deepening the Corporate Bond Market,' which outlines a comprehensive policy roadmap for the next five years. Fixed income investments are not merely portfolio stabilizers for households; they serve as the backbone of long-term capital formation, essential for fueling India's ambitious growth targets.
SEBI's Foundation and the Path Forward
Over the past few years, the Securities and Exchange Board of India (SEBI) has implemented significant regulatory reforms to strengthen the bond market. Key initiatives include the introduction of Online Bond Platform Providers (OBPPs), electronic bidding platforms, a minimum face value of ₹10,000 for bonds, and enhanced disclosure standards. These measures have laid a robust foundation for market development. However, to truly democratize bond investing and meaningfully increase retail participation, the Union Budget 2026 presents a pivotal opportunity to address several structural bottlenecks that hinder Indian investors.
1. Rationalize TDS on Bond Interest Income
The introduction of Tax Deducted at Source (TDS) on bond interest income in the Union Budget 2023 has inadvertently created friction for retail investors. While the intent was to improve tax compliance, the outcome has been increased complexity in return calculations, such as using XIRR (Extended Internal Rate of Return), and cash-flow mismatches. Notably, from 2008 to 2023, there was no TDS on interest from listed corporate bonds, making this a recent shift.
Unlike fixed deposits, bond investments often involve secondary market trades, accrued interest adjustments, and varying holding periods. The application of TDS in such scenarios complicates the assessment of actual post-tax returns and increases the operational burden of reconciliation during income tax return (ITR) filings or when submitting Form 15G/15H for tax deductions. Removing TDS on bond interest income would simplify the investment process, enhance transparency in yield computation, and encourage investor participation without compromising tax collection, as interest income remains fully taxable at the time of filing returns.
2. Introduce a Fair and Predictable Tax Regime for Bond Interest
Currently, interest earned from bonds is taxed at the investor's applicable slab rate, unlike equities, which benefit from a clear distinction between short-term and long-term capital gains with concessional tax rates. This disparity creates an uneven playing field, potentially discouraging long-term participation in corporate bonds. For many retail investors earning annual returns in the range of 7–12%, slab-rate taxation significantly erodes post-tax outcomes, making bonds appear less attractive despite their lower volatility and capital preservation characteristics.
A simplified and predictable tax framework—such as a flat tax rate of around 20% on bond interest income—would bring parity across asset classes. This reform would encourage households to allocate more savings to bonds, support long-term investing behavior, and help channel domestic capital into India's growing economy, aligning with broader financial inclusion goals.
3. Create a Uniform Distribution Framework for Bonds
While mutual funds, equities, and insurance products operate under well-defined, standardized distribution frameworks, bond distribution in India remains fragmented across multiple participant types and channels. This lack of uniformity limits scalability, restricts investor trust, and creates uncertainty for intermediaries.
A clear, regulator-approved distribution framework for corporate bonds—similar to the Authorised Person (AP) structure in equities and AMFI Registration Numbers (ARNs) in mutual funds—can help enforce fit-and-proper criteria, define roles and accountability, and standardize disclosure and suitability practices across the industry. Such a framework would enhance market integrity and foster greater confidence among retail investors.
4. Flatten the Government Bond Yield Curve
For effective transmission of rate cuts by the Reserve Bank of India (RBI) into the economy, flattening the government bond yield curve is essential. Following RBI rate cuts of 125 basis points last year, the 10-year bond yield has barely moved 20 basis points lower, and yields on 15-year bonds have actually increased. This phenomenon is largely attributed to technical supply factors and deteriorating sentiment due to a weakening rupee.
Achievement around fiscal deficit numbers and clarity on the government's future borrowing program would instill confidence in markets on the longer end of the bond curve, helping to bring yields down. Financial prudence, closely monitored in the budget, will be critical to encouraging a robust bond market and supporting economic stability.
Conclusion: A Call to Action for Budget 2026
The Union Budget 2026 has the opportunity to send a strong signal: that bonds are not just institutional instruments but a core part of India's household investment landscape. Enabling this shift will be critical as India moves towards its next phase of economic growth, encapsulated in the vision of Viksit Bharat 2047. By addressing these key reforms, policymakers can unlock the full potential of the corporate bond market, driving financial inclusion and sustainable development.
