The Reserve Bank of India (RBI) cut policy rates by 25 basis points (bps) in a surprise move on January 15 on account of easing inflation and expectations of inflation, among other factors. This rate cut came in after a long wait as the RBI had maintained a status quo for quite some time. However, now that it has cut rates and has stated that it won’t mix up its monetary policy stance, there might a plenty of bond issues in the market soon.

Here’s why...
The reason for the same is that when interest rates decline, it becomes cheaper for companies to borrow funds and becomes easier for banks to secure deposits. In a falling interest rate scenario, their appetite for credit increases. Since the time RBI has cut rates (January 15) companies such as HDFC, Oriental Bank of Commerce, National Housing Bank (NHB), among a few others, have already raised funds. Many others such as Indian Railway Finance Corporation (IRFC), Power Grid, Rural Electrification Corporation and so on might be issuing bonds shortly.

Even investors, including Foreign Institutional Investors (FIIs) are enthusiastically purchasing bonds as the markets are expecting further rate cuts in the future. If rates fall, the prices of bonds rise, as they share an inverse relationship. Thus, investors believe that buying bonds now will be profitable as their prices might rise later. Falling interest rates are a win-win situation for both issuers and investors.

Would markets absorb huge supply of bonds?
Credit growth has been sluggish so far. This is why despite of lower growth in supply of money (as measured by M3) the liquidity indicators have remained stable till now. Due to lower credit growth, many banks have cut rates on deposits in recent times. Yields on 1-month CDs ranged from 8.15% to 8.30% on an average over the last 1 month. While those on 3-month papers were marginally higher and stayed in the range of 8.30% to 8.50%. It is noteworthy that, higher interest rates were seen as one of the major barriers to higher credit growth so far. Policy rate cut has sent out a positive message to those who had put their borrowing plans on the back burner till now, in anticipation of securing funds at a lower cost. Now that, borrowing cost is expected to go down, one might expect a healthy credit growth going forward.

However, it remains noteworthy that, due to single digit growth in time and demand deposits with banks and money available with public, M3 growth in December fell to a multi-year low. In case markets witness hectic borrowing programmes going ahead, at some point in time, liquidity might be challenged. Furthermore cheaper credit can’t be taken for granted as further rate cuts are contingent upon a number of factors.

Factors that might affect rate cuts are:
 

• Future trend in inflation
• Government action in the areas where supply side constraints are posing threat of higher inflation
• Infrastructural development in addition to availability of key inputs such as power, land and minerals
   

For aforementioned reasons it would be prudent to avoid speculating on further rate cuts. Instead, invest in debt funds and let the investment professionals take calls on interest rates and money supply.

PersonalFN believes that as an investor, you would be better off if you concentrate on your financial goals. While investing in debt funds, always consider your time horizon first before zeroing on any fund. Mind you, debt funds are not risk free. If you have a time horizon of more than 3 years, you might invest in long-term debt funds, provided you have a high-risk appetite. Taking a cautious approach, you can even stagger your investments over next few months. Also, make sure that your exposure to long-term debt funds does not exceed 20% of the entire debt portfolio.

It may also be wise to invest in dynamic bond funds, as they have the flexibility to hold debt instruments across maturities. While G-sec funds may start delivering returns as fundamentals improve and policy rates start to relax, going overboard now may not be very prudent.

If you have a short-term investment horizon of 3 to 6 months you could consider investing in ultra-short term funds (also known as liquid plus funds). And if you have an extreme short-term time horizon (of less than 3 months) you would be better-off investing in liquid funds.

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