Debt Investment in the Wake of Recent RBI Measures

Overview

We all know that equity plays an important role in long term wealth generation and should be a large part of one’s asset allocation in the longer term. However, after the recent RBI measures scenario debt instruments have become more attractive than ever due to their dual capability of providing tax efficient returns while at the same time providing stability to the overall portfolio through diversification. Also, companies are coming up with very attractive coupon rate for their NCDs which apart from their attractive yield also generate good capital gains as most of these NCDs are also traded in secondary market.

Popular Modes of Investing in Debt

·         Debt Mutual Funds

·         Company’s NCDs/Bonds

Benefits of Debt Instrument in Current Scenario

·         Higher yields

·         Safe Heaven

·         Highly liquid debt instruments in offering

·       Good chance of handsome capital gains on debt fund as interest rate cycle reaches its peak level

·         Portfolio Diversification

Recent RBI Measures Have Spooked Markets

• RBI has recently hiked the MSF rate by 200 bps to 10.25%. MSF is the penalty rate at which banks can borrow over repo rate (earlier it was 100 bps over repo rate).
• The central bank also imposed an overall cap of Rs 75000 Cr on Liquidity Adjustment Factor (LAF) borrowing.
• Sale of Government of India securities was also announced to drain liquidity.
• Further on July 23rd the cap on LAF borrowing was brought down to 0.5% of NDTL and CRR maintenance requirements

Indian markets were caught off guard with this move and rates jumped in an almost unprecedented manner.

•         Short term rates shot up by ~300 bps

•         Rates on the long end jumped by ~90 bps

Measures May be Temporary

We believe that recent RBI measures are temporary for the following reasons:

·         Higher rates along with slow growth can damage banks and corporate India balance sheet.

·         All policy makers conveying that measures are temporary in nature.

·         Key rates are still untouched which means these are temporary measures and intention is not to hike rates.

Our Advice to Investors

We strongly recommend investors to use a part of their investment in debt and switch to equity in phased manner to maximize returns. While traditional Instruments like FDs, Bond are not volatile but they are not tax efficient too. We believe that Mutual Funds are the best option owing to Tax Benefits and professional management. Also, due care should be taken to rebalance the portfolio in timely and phased manner.

By Rajat Gupta– Research Analyst – Concept Securities Private Limited