Do you perceive debt funds to be safe? Get the reality check!   Aug 21, 2013





India badly needs inflows of foreign capital; at the same time it has to curb dollar outflows. This seems to be the only way that may significantly boost Indian rupee which is making fresh all-time lows almost every day. In a bid to discourage speculation in rupee, RBI imposed stringent measures by way of sucking out excess liquidity. But instead of taking positive cues from policy actions; rupee has moved further down. Notably, falling rupee is dragging markets and falling markets are pushing the rupee further down. Over last one month, equity markets have fallen nearly 10% while yields on 10 year sovereign benchmark bond have surged about 16% causing a severe loss to investors.


Falling rupee and rising yields
Indian Rupee aginst US Dollar yeild on 10-Yr G-Sec Bond
Data as on August 19, 2013
(Source: ACE MF, The Economic Times)


As seen in the graph above, yield on 10 year G-sec bond has jumped substantially in August and rupee also fell quite sharply. One of the main reasons has been outflow of money from capital markets. Foreign Institutional Investors (FIIs) have been relentlessly sellingIndian debt. As per data published by Security and Exchange Board of India (SEBI), they pulled out about 4.2 billion USD in 2013 of which about 0.98 billion USD have been withdrawn in first 19 days of August 2013. On the other hand, equities have seen inflows of 8.46 billion USD from the beginning of 2013. But this month through August 19, inflows in equities too have turned negative, knocking off rupee.

What are the reasons?
Lower growth, high retail inflation caused by extremely high food prices and rupee volatility kept investors away from Indian debt. Moreover, rising treasury yields in the United States are making Indian debt unattractive in relative terms. Over last 1 month, yields on 10-year US treasuries have shot up 15% causing massive-selloffs in Indian debt. Yield spread between 10-year G-Sec bond in India and 10-year US treasuries has widened over last 1 month. This suggests that there are takers to Indian debt only at a higher yield. Furthermore, possibility of inflation escalation on account of higher import bill and high food prices makes the job of RBI even difficult. Rupee volatility and higher inflation expectation may force RBI to overlook threats of economic slowdown. India is on the brink of losing its rating. Under such circumstances, sentiment of investors remains very low and unless India’s current account deficit is reduced significantly, it is unlikely that Indian rupee will recover.

While India needs 75 billion USD to finance its current account deficits; so far inflow of foreign capital has not been encouraging. The government targeted to reduce non-essential imports such as imports of gold. Along with which, recently, Indian Government imposed some capital controls. Overseas direct investment limit for individuals was reduced to 75,000 USD from 2,00,000 USD earlier. Furthermore, companies can now invest outside India only upto 100% of their networth which is significantly lower than old limit of upto 400%. Net overseas investments of Indian companies were 7.5 billion USD last fiscal while outflows by individuals were roughly about a billion dollars. Although government says these measures are being taken only to keep dollar outflows in check; markets seem to be unconvinced with it. This has certainly raised some doubts in the mind of FIIs who might have treated it as a first round of capital controls which might be tightened further. This is why yields have skyrocketed over last few days. Rising yields would be a negative to your debt fund as bond prices fall with rising yields.

PersonalFN believes that, betting on direction of yields and interest rates would be hazardous at present. As India draws closer to 2014 Lok Sabha elections, market volatility would increase further. Don’t forget, at present yield curve remains inverted i.e. short term maturity instruments are earning higher rate of return than that earned on long term maturity instruments. Till, rupee stabilises, inflation expectation falls and yield curve returns to normalcy, it would be a bumpy ride for debt funds. Beware! Debt funds are not risk free. PersonalFN believes you shouldn’t have more than 20% of your debt portfolio in long term debt funds.


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Oct 15, 2013

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