Indian investors need to plan their debt investments as the US Fed indicates rate decreases. For possible capital growth, experts advise concentrating on gilt and corporate bond funds while taking individual risk and investing profiles into account.
RBI Rate Cut Outlook
Expectations have grown that the Reserve Bank of India (RBI) would follow suit and lower rates in its next policy meeting on October 1 after the US Federal Reserve lowered benchmark interest rates by 25 basis points and signaled more rate reduction in the months ahead.
In its August policy meeting, the RBI reaffirmed its policy stance as “neutral” and held the repo rate at 5.5% after delivering a larger-than-expected rate drop of 50 basis points in June of this year.
The RBI may lower rates and further boost India’s economic development now that the Fed rate reduction cycle has begun, free from concerns about inflation and the depreciation of the currency.
Monetary easing increases consumption, reduces borrowing rates, and often triggers a stock market rise. This begs the important issue of how we should invest in debt while interest rates are falling.
Bonds and rate reductions
Similar to stocks, government bonds, corporate debentures, and fixed-income mutual funds are also impacted by central banks’ rate-cutting initiatives.
Because lower borrowing rates raise the likelihood of more consumer spending and improved company profitability, a rate drop may signal a restoration of risk appetite for stocks.
For stocks, on the other hand, it seems a little more complicated.
For debt investors, monetary easing may provide both opportunities and difficulties. This is due to the fact that interest rates and bond prices have an inverse relationship.
Bond Prices Versus Yields
The coupon rate is the fixed interest rate associated with bonds. Newly issued bonds provide a lower coupon rate in response to the rate decrease, reflecting the new, lower interest rate environment.
Because their set coupon rate makes them more appealing than new bonds with lower rates, the price of longer-duration bonds increases during periods of monetary easing.
What is the purpose of this? The market price of old bonds rises as a result of the influx of debt investors looking to purchase them. Bonds have set coupon payments, so as bond prices rise, yields fall.
Assume, for instance, that you purchase a bond of ₹100 with a coupon rate of 10%. Every year, you will get ₹10 in interest. Due to the set coupon, you will only get ₹10 interest even if demand drives the bond’s market price up to ₹110. Your yield, or effective return, decreases to around 9.1% at this higher price. For this reason, we argue that bond yields and prices move in opposing directions. The return decreases when the bond price rises and vice versa.
Does this imply that you should refrain from investing in debt during periods of rate reductions?
Investment in debt during periods of monetary easing
Grip Invest‘s founder and group CEO, Nikhil Aggarwal, believes that if the Fed signals further rate reduction, the RBI may do the same to boost growth and control capital flows.
Indian debt investors have the chance to position themselves ahead of the rate-cut cycle since lower rates result in higher bond yields for fixed-income investors.
Since the RBI has greater short-term control, a rate reduction environment often results in a steeper curve. Due to RBI easing, front-end prices have already climbed, and the reinvestment risk also becomes more prominent at the shorter-term end. According to Aggarwal, it could be appropriate for investors who want to reduce their cash holdings.
However, since you are taking on a lot more duration and possible volatility, you do not gain much higher returns for assets with a longer tenure. Therefore, this would be most advantageous for mid-term bonds throughout the rating curve. These may provide you long-term, steady returns, good yields, and even price increases if RBI rates decline, Aggarwal added.
Corporate And Gilt Funds
Tata Mutual Fund‘s head of fixed income, Murthy Nagarajan, emphasized that the RBI and the Indian government are attempting to decrease the supply of old documents since insurance firms and the Employee Provident Fund Organization (EPFO) are not as interested in them.
In the next months, there should be a decrease in the 80 basis point difference between 10-year and 40-year government securities. According to Nagarajan, investors may choose to put their money into corporate bond funds and gilt funds because of their appealing carry and potential for capital growth in the next months.
Long-Duration Bond Strategy
After the US Fed lowered its benchmark rate by 25 basis points and hinted at more reductions, Abhishek Bisen, Senior EVP and fund manager of fixed income at Kotak Mutual Fund, thinks the RBI may also lower rates.
Despite having solid economic fundamentals, the Indian yield curve is nevertheless steep in this context, with longer-term rates being comparatively high when compared to other nations.
This implies that long-duration bonds are cheap, offering investors chances, according to Bisen.
“We advise investing more in government bonds at the long end of the curve in order to take advantage of possible capital growth in the event that yields decline. But, according to Bisen, debt investors should think about asset allocation in light of their risk tolerance, return goals, investment horizon, taxes, legal considerations, liquidity requirements, and any other particular limitations.