Summary: Deep discount (or zero-coupon) bonds are returning to India as PSU issuers, such as REC, PFC, etc., seek cost-effective long-term funding for infrastructure growth. This guide breaks down why they are back in focus in 2026, how they work, and what investors should keep in mind.
Quick overview
- Deep discount bonds are making a comeback in India’s debt market
- PSU issuers such as REC, PFC, HUDCO, and IRFC received approvals for zero-coupon, deep discount issuances in 2025
- These instruments help issuers raise long-term capital at potentially lower borrowing costs
- Investors receive lump-sum maturity payouts rather than periodic interest payments
- Falling interest rate expectations initially boosted demand, though liquidity concerns later slowed investor appetite
- Deep discount bonds may suit long-term investors, though they carry duration, liquidity, and taxation considerations
Deep discount bonds have traditionally occupied a small corner of India’s debt market. For a long time, they operated as a niche instrument, occasionally issued, rarely discussed, and even less understood outside institutional circles, until 2025.
Public-sector issuers, especially those tied to infrastructure financing, began revisiting zero-coupon or deep discount structures in response to practical pressures: large funding requirements, evolving interest rate expectations, and the need to manage long-duration liabilities more efficiently.
What makes this shift interesting is not just the revival of these bonds but also their timing. It connects directly to India’s infrastructure financing cycle and to how Public Sector Undertakings (PSUs) are adapting their balance sheets to it.
To see why this matters, we must first understand the structure of deep discount bonds.
What are Deep Discount Bonds?
Deep discount bonds are debt instruments that do not pay periodic interest. Instead, you buy them at a discounted price significantly below their face value and receive the full face value when the bond matures. Your return comes from the difference between the purchase price and the maturity value.
Unlike traditional bonds, you do not receive regular coupon payments. You invest, hold the bond until maturity, and receive a single payout at the end of the term. The returns compound within the instrument, so you do not have to reinvest periodic interest payments.
For this reason, global markets often classify deep discount bonds as zero-coupon bonds. In India, you will typically find the term “deep discount bond” used for long-term PSU and infrastructure-related borrowings, although the basic structure remains largely the same.
Why Deep Discount Bonds are in Focus
Rural Electrification Corporation (REC) was one of the early names to bring deep discount structures back into the market in recent years. In September 2024, it raised ₹5,000 crore through a zero-coupon bond issue at a yield of 6.25%. Investors placed bids worth almost seven times the issue size, showing strong demand for this structure.
REC’s success encouraged other PSUs to consider similar issuances. The government later approved deep discount bond programs for Power Finance Corporation (PFC), Housing and Urban Development Corporation (HUDCO), and Indian Railway Finance Corporation (IRFC). Reports also linked NABARD, SIDBI, IREDA, and Power Grid to discussions around similar fundraising plans.
The appeal goes beyond investor demand. Deep discount bonds help issuers raise long-term funds without making regular interest payments, making them particularly suitable for infrastructure projects.
Understanding the features, risks, and tax treatment of deep discount bonds is important before evaluating where they fit within a fixed-income portfolio.
Why PSU Issuers are Returning to Deep Discount Bonds
Here are the key reasons why the popularity of deep discount bonds is growing:
India’s Infrastructure Financing Push
India’s infrastructure pipeline is large, capital-intensive, and long-term in nature. Whether it is renewable energy expansion, railway modernization, power transmission upgrades, or housing finance, these projects require significant upfront capital.
For PSUs sitting at the center of this ecosystem, traditional coupon-bearing debt creates a recurring obligation. Interest payments must be serviced periodically, regardless of whether the underlying project has begun generating revenue.
This creates pressure on cash flows. Deep discount bonds change that structure.
Instead of paying interest each year, issuers raise money up front and settle the principal at maturity. This structure aligns well with infrastructure projects that generate cash flows only after several years of development.
A Reuters report highlighted REC’s issuance as part of a wider trend in which PSU issuers are rethinking their borrowing strategies to support India’s growing infrastructure financing needs.
In simple terms, it reduces near-term cash-flow obligations. They don’t have to manage annual interest outflows while still building or financing large projects.
Falling Interest Rate Expectations Changed Borrowing Strategy
The second factor is the rate cycle. When interest rates are expected to fall or remain stable, issuers tend to lock in funding for longer durations. Borrowing decisions become influenced not only by cost but also by the ability to secure long-term funding before market conditions change.
Deep discount bonds allow that. Instead of paying coupons tied to evolving market rates, issuers fix the cost of borrowing at the outset and avoid ongoing exposure to interest rate movements.
It also removes refinancing uncertainty. If the rate cycle turns, issuers don’t need to come back to the market frequently to roll over debt. This predictability is valuable, especially for large PSU borrowers managing long-term capital expenditure.
Why Investors Find Deep Discount Bonds Attractive
Investors may find deep discount bonds attractive due to the following two reasons:
No reinvestment risk: From your perspective, one of the key advantages of deep discount bond investing is what doesn’t happen during the investment period. In regular coupon bonds, you receive periodic interest. That money then has to be reinvested, often at uncertain future rates. If rates fall, your reinvested returns are lower, which impacts overall yield. Deep discount bonds remove that layer completely. The returns compound within the bond itself, and since there are no periodic interest payments, investors do not have to make reinvestment decisions. That makes returns more predictable over long horizons, especially for institutional investors and treasury desks.
Potential tax efficiency: There is also a tax dimension associated with deep discount bonds, though it is often misunderstood. Since returns are realized at maturity, they are typically treated as capital gains rather than periodic interest income, depending on structure and holding period. This can sometimes result in more efficient post-tax outcomes, especially for investors in higher tax brackets. But it is important not to overstate this. These are not tax-free bonds. The benefit lies in the timing and classification of income, not the exemption.
Deep Discount Bonds in India in 2026: Emerging Liquidity and Pricing Concerns
Although issuer interest in deep discount bonds has increased, investor demand has been more selective. While some issuances attracted strong institutional participation, others faced slower subscription levels. In certain cases, issuers adjusted or delayed planned offerings because investors were unwilling to accept the proposed pricing.
For example, PFC reported delays in its zero-coupon bond issuance, highlighting the challenge of aligning issuer funding requirements with investor return expectations in a market seeing a growing supply of such instruments.
Another risky consideration is liquidity. Deep discount bonds typically have long maturities and do not make periodic interest payments, which can limit secondary-market trading activity compared with more conventional fixed-income instruments.
As a result, investors may need to hold these securities for extended periods before realizing their returns. This can reduce their appeal for investors who prioritize liquidity and flexibility, even when the underlying credit quality remains strong.
Who Should Consider Deep Discount Bonds?
These bonds may not fit every type of investor. They tend to fit better in portfolios where liquidity is not a near-term requirement.
Suitable investor profiles include:
- Long-term institutional investors, such as pension funds, insurance companies, and provident funds, with long-term liabilities
- Banks and financial institutions, looking to park surplus funds in long-duration instruments
- High-net-worth investors (HNIs) with long investment horizons and no near-term liquidity needs
- Sovereign wealth funds and other long-term investment pools, seeking predictable return profiles
- Infrastructure-focused investors who want exposure to long-gestation assets through debt instruments
The key is matching the instrument to the investor’s needs. These instruments work well when the holding period is clear from the beginning.
You may want to avoid them if you are an income-focused investor seeking regular cash flows, or an investor who may require liquidity before maturity, or a conservative debt investor who is uncomfortable with long-duration exposure.
Conclusion
Deep discount bonds were not designed to be mainstream retail investments in India. That was never their intended role. However, their growing relevance in PSU borrowing strategies is remarkable.
Their future depends mainly on interest rate conditions and investor demand for long-duration, low-liquidity instruments. If rates remain stable or decline, and infrastructure funding needs remain strong, more issuers may revisit this structure. Even then, deep discount bonds are likely to remain a selective financing tool rather than a mass-market product.
In 2026, they are best seen not as a trend in their own right, but as a signal of how India’s infrastructure financing approach continues to evolve.
