$10 Billion India fund chooses government bonds, shuns corporate debt as spreads become unattractive.

DSP Investment Managers Pvt. is another fund manager to choose sovereign notes over Indian rupee-denominated corporate bonds, adding to strains on company finances when they need to build up buffers to deal with the economic fallout from the pandemic. Spreads on corporate bonds need to be higher to compensate for the credit risk, Saurabh Bhatia, head of fixed income at DSP Investment, which manages 772 billion rupees ($10.3 billion) worth of assets in India, said in a telephone interview. “We remain overweight in sovereign bonds,” he said.

India’s central bank is keeping the doors open for more easing after it started using unconventional cash measures in late March to guard against the economic impact of Covid-19. Premiums on 10-year company debt over sovereign bonds have narrowed after the Reserve Bank of India funded banks’ purchases of 1.13 trillion rupees of corporate bonds and cut benchmark interest rates to the lowest level since at least 2000.

Quantum Asset Management Co. also recommends avoiding higher-risk India credit because the world’s-biggest lockdown has significantly weakened the debt-servicing capacity of many companies. This wariness among investment funds is clouding the outlook for bolstering finances even amid the stimulus supported buying of riskier and short-term debt from Indian lenders.

“We are building more duration in our portfolio and for that are now buying government bonds maturing in seven to 12 years rather than six to nine years we bought until last fortnight,” said DSP Investment’s Bhatia.

The yield gap between top-rated 10-year corporate bonds and similar-maturity government debt has been tightening since late May, after the RBI cut rates and pledged to take more measures. The spreads are at a two-month low of 82 basis points, according to data compiled by Bloomberg.

A slump in demand due to the pandemic “could create a negative spiral in the economy and hence in the loan and bond markets,” Pankaj Pathak, a fixed-income fund manager at Quantum, wrote in a research note last week. “We see the risk of a higher amount of rating downgrades and defaults in the next two years.”