In 2022, when the Reserve Bank of India (RBI) increased the repo rate, returns of existing debt funds fell sharply. The Average Annualised return which was 8-10% in 2020, dropped to 2-3% returns. This happened because new bonds started offering higher interest rates, making older bonds with lower yields less attractive. This is how debt funds work: when interest rates rise, bond prices fall.
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The opposite also holds true: when interest rates fall, older bonds with higher locked-in rates become more valuable.
Since February 2025, the RBI has cut the repo rate twice. This has left many investors with a key question: Is this the right time to invest in debt funds?
In this article I will try to walk you through the impact of debt funds – long-term and short-term – when the repo rate decreases.
What happens to debt funds when the repo rate decreases?
When there is a repo rate cut, fresh bonds are issued at lower rates; this increases the value of older debt funds which were issued at higher rates. Hence, the value of the existing debt fund increases. It can also be called an increase in NAV (Net Asset Value).
But the impact on debt funds after repo rate cuts differs from type to type. In this blog we will talk about two types of debt funds.
- Short-term debt funds invest in bonds that mature quickly. So, their value changes only a little when interest rates move.
- Long-term debt funds hold bonds for longer durations. So, they benefit more when rates fall but can also lose more when rates rise.
Let’s understand further.
Impact of a repo rate cut on long-term debt funds
Long-term debt funds invest mainly in fixed-income securities such as government bonds, corporate bonds, and other instruments with a period of more than seven years.
They are more affected by repo rate cuts, as these mutual funds hold bonds that lock in higher interest rates for extended periods.
When the RBI cuts the repo rate, newly issued bonds in the market offer lower yields. However, the bonds already held by the fund continue to yield higher interest rates, making them more valuable.
As bond prices rise with falling interest rates, the NAV (Net Asset Value) of long-duration debt funds increases more sharply compared to short-duration funds.
Let’s understand this with an example –
Suppose a long-duration debt fund holds government bonds issued two years ago with a fixed coupon rate of 7.5% and a maturity of 10 years. Now, the RBI cuts the repo rate, and new government bonds are being issued at a lower yield of 6.5%.
Because the older bonds in the fund’s portfolio still offer a higher return (7.5%), they become more attractive in the market. As a result, the market price of those bonds increases, and so does the fund’s NAV.
If the bond originally priced at ₹100 is now valued at ₹106 due to the rate cut, the NAV of the mutual fund holding it will reflect this appreciation. This capital gain is in addition to the regular interest income, making long-duration debt funds significantly benefit from repo rate cuts.
What about short-term debt funds?
Short-term debt mutual funds invest in instruments with shorter maturities. These funds are less impacted by rate changes.
Why?
Because they hold bonds for a shorter period, any price benefit from older, higher-yielding bonds is quickly replaced as the fund reinvests in newer, lower-yielding instruments. So, while NAVs may rise temporarily after a rate cut, the effect is short-lived.
Should you invest in a debt fund now?
Your decision should depend on your risk appetite, investment horizon, and income profile.
- If you seek relatively stable returns and are willing to hold your investment for 1–3 years, long-duration debt funds and gilt funds are positioned to perform well in the current falling rate cycle.
- If you prefer lower volatility and shorter tenures, short-duration funds may be more suitable, though returns could be moderate.
Historical data: How have long-term debt funds performed after rate cuts?
| Period | Repo Rate Change | Average Long Duration Returns | Short Duration Fund Returns |
| 2025 (YTD) | 6.5% → 6.0% | Already showing double digit returns – 11-13% | 8-10% |
| 2019–2020 | 6.5% → 4.0% | 10% | 8-9% |
| 2015–2016 | 8.0% → 6.5% | 13% | 8-10% |
Data from ACE MF Central
In 2019-2020, when the RBI cut the repo rate by 250 basis points (from 6.5% to 4%). Long-duration funds delivered, on Average 10% annualised returns.
Whereas short-duration funds returned a modest return of 8% on average.
After RBI repo rate cut by 25 basis points twice—first from 6.5% to 6.25% and then to 6.0%—long-duration debt funds have already seen a notable rise in NAVs. The returns are almost in double digits.
To Summarise
Every time the RBI has cut the repo rate, long-duration debt funds have historically outperformed short-duration debt funds in the subsequent 6–12 months.
Will there be another repo rate cut?
According to 1 Finance’s Macroeconomic Research, RBI may continue with an accommodative stance through 2025. If inflation softens and global trade stabilises, expect another 50–75 bps in potential cuts.
| Scenario | Additional Cut Forecast |
| Trade tensions ease by end-2025 | 50 bps |
| Growth slows, uncertainty persists | 75 bps |
To conclude
Debt funds are not entirely risk-free, but they offer strategic opportunities—particularly when interest rates fall. With the RBI signalling an accommodative stance and two rate cuts already implemented in 2025, long-duration debt funds are well-placed to deliver attractive returns in the current cycle. Investors should consider their time horizon and risk tolerance before allocating, but the direction of interest rates suggests long-duration funds could be a rewarding bet in the months ahead.
