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Equity markets falling: Should you invest in debt?

Volatility in the equity markets makes it imperative to hunt for an avenue, which provides capital protection. Reserve Bank of India has already announced measures to lure retail investors towards government bonds. Retail individual investors would be provided direct access to both primary and secondary market platforms without any intermediaries.

June 11, 2015 3:26 IST | IIFL
Indian debt markets have witnessed remarkable buoyancy during the last 18 months, with foreign portfolio investments amounting to US$26.2bn in 2014 and US$5.6bn during the first half of this calendar year. Moderation in inflation, effective growth reforms, resilient domestic currency and a series of interest rate cuts set the bond prices soaring. Effectively, 10-year benchmark sovereign bond yields moved substantially lower towards 7.7% during February this year, when compared with a high of 9% during April 2014. However, the sentiment soured during May, with outflows reported at US$2.2bn. The liquidation was in complete contrast with the net purchases reported during past several months.  Yields on the 10-year G-Sec reversed course and in the process tested the high of 8%. Probability of rise in food prices due to unseasonal rains dented the market psyche. Markets were also cautious regarding the probability of a rate hike by US Federal Reserve this year and ensuing surge in US bond yields.
 
At the current juncture, yield on new 10-year benchmark 7.72 G-Sec 2015 is trading at 7.85%, while for old 10-year benchmark 8.4 G-Sec 2024 is quoted at 8.05%. Market participants are disheartened by RBI’s cautious stance. Although the central bank decided to trim repo rate by 25 basis points at its June meeting, the wording of monetary policy indicates a long pause before the next move on the interest rates. The policy statement mentions that there is an element of uncertainty to the inflation outlook, wherein the probability of poor monsoon poses as a risk. In this respect, India’s Meteorological Department expects the total rainfall to be 88% of the normal monsoon.
 
Indisputably, the trajectory of bond prices is influenced by the interest rate outlook. Monetary policy will continue to be data driven, with the central bank committed to its disinflationary stance. However, RBI is open to monetary easing if the macroeconomic situation permits the same. The next move is primarily dependent on the progress of monsoon and its effects on inflation. Better monsoon and positive government action can pave the path for further reduction in interest rates. In event of a poor monsoon, RBI may not act on the interest rates for next two monetary policy meetings. Nevertheless, we expect the government to contain food inflation through effective food management policies. The incumbent regime has already announced measures to import huge quantum of pulses in order to combat rising domestic prices. We also need to understand that rise in food prices will be transient in nature and the dust can settle down, provided effective measures are initiated on the supply side. Better fiscal consolidation, effective reforms, improving economic growth and containment of inflation should ensure additional rate cuts to the tune of 50-75 basis points by the end of this fiscal year.
 
Volatility in the equity markets makes it imperative to hunt for an avenue, which provides capital protection. Reserve Bank of India has already announced measures to lure retail investors towards government bonds. Retail individual investors would be provided direct access to both primary and secondary market platforms without any intermediaries.
 
From an investment perspective, it makes sense to adopt a balanced approach and allot some part of the portfolio to the debt markets. 

The author is Senior Analyst at IIFL

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