Outlook of Debt Market for 2nd half of the Year 2022

 

Outlook of Debt Market for 2nd half of the Year 2022

We would begin the topic by covering basic concepts relevant to the readers for a better understanding of this article.

Sometimes, banks may need liquidity to take care of an unprecedented spurt in the withdrawal of funds by their account holders, or to maintain the prescribed limit of the Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). In such situations, banks may have to take loans from RBI by keeping Government Securities (G-Secs) as collateral. At the end of the loan term i.e. either overnight or 7 days, the bank repurchases the Government Securities from RBI by repaying the loan amount along with a pre-decided interest rate called Repo Rate – which is the interest rate at which the RBI lends money to the banks. In case, the bank defaults in paying the borrowed money back to the RBI, the latter sells the G-Secs that were kept as collateral.

Regulating the Repo rate is one of the tools available with RBI to regulate inflation (called Hawkish monitory policy) and growth in the economy (called Dovish monitory policy).

Consider a situation where the economy is facing high inflation; the RBI will keep increasing the Repo rate with an objective to curtail part of available liquidity in the hands of consumers. 

With the increase in the Repo rate; banks have to pay more interest to borrow money from RBI. Banks in turn would raise the lending rate on the loans given to their borrowers. This move, leaves consumers with less money thus, reducing their purchasing power, leading to a decrease in the demand for goods and services - making them cheaper; eventually cooling down the inflation.

The rationale behind RBI’s decision to increase Repo Rate: Based on the assessment of the economic situation, the Monetary Policy Committee (MPC) of the RBI, decided to increase the policy repo rate under the Liquidity Adjustment Facility (LAF). The decision to tame the inflation was made in light of growing inflation, the ongoing war between Ukraine and Russia, high crude prices, and global commodity shortages. Besides, US Federal Reserve increased interest rates by 50 basis points to 0.75%-1% in the May 2022 meeting, thus impacting the markets across the globe.

The RBI wants to keep inflation under control, which is already close to 7%, as well as manage and monitor money flow into the banking sector. Therefore, RBI may continue to further hike Repo rates to reach the level of 6 to 6.50% by March 2023.

 

Effect of rising Repo Rate on Fixed Deposit:  The rate hike is welcomed by the deposit holders of banks and corporates, as fixed deposits have become an attractive option to invest with surges in interest rates.

 

Effect of rising Repo Rate on Debt Mutual Funds: Assume that a 10-year Government bond was issued at a face value of Rs. 100 at 8% interest (coupon) rate, which implies the yield in this bond is Rs. 8/-

If the Repo rate increases and the lending rate is increased to for example 10%, that would mean that the yield for the new bond issued will be Rs. 10 /-. This will reduce the demand for the 8% bond since the 10% coupon rate promises better returns.

Therefore, to make the former more attractive, the face value of the bond will be decreased to, say, Rs. 90/-. So, the yield for this bond now becomes 8.89% (8/90*100), which is higher than the original- making it more attractive.

Hence, an increase in interest rate is directly proportional to the yield and inversely proportional to the face value. This means that the Bond prices are inversely correlated to yield.  When interest rates and the yield goes up, bond prices decline (and vice-versa) resulting in mark-to-market losses for debt mutual funds.

After the RBI's announcement, the 10-year bond yield, which had been steadily rising in recent months, inched up to 7.40%. As a result, the net asset value (NAV) of debt mutual funds has fallen sharply, particularly for medium and long-duration funds. An increase in interest rates will have a negative impact on debt funds with a longer duration.

Conversely, a decrease in the Repo rate may make the debt schemes more attractive as it may increase the NAV of the debt schemes. The margin of gain will depend on the average maturity and the securities the scheme holds.

Effect of rising Repo Rate on Equity Market:  The Equity market typically goes down with the RBI's policy rate hike.  When there is plenty of liquidity, the equity market does well. If the RBI tightens the interest rates, the stock market is adversely impacted. Following the RBI's action, banks tend to raise their lending rates, thus making loans more expensive. As a result, companies will have to pay a higher interest rate to borrow money, indirectly impacting their liquidity position, and leading to a decrease in equity fund returns.

What should an investor do?

 

Looking at the inflation of 7%, the terminal Repo rate should stand somewhere at 6-6.5%. Therefore, investing in Corporate Fixed Deposits (choose only AAA-rated CFDs) would offer a better interest rate over the bank fixed deposit.

Invest in debt mutual funds if you have a large investment portfolio. Debt mutual funds are taxed at 20% with indexation if you hold the money for more than three years. If you are investing for less than three years, they don’t have any tax advantages and are taxed like bank deposits at applicable income tax rates.

If you decide to invest for three years or more, look at investing in the Corporate bond funds, and Banking & PSU funds. Also, investing in the Target Maturity Funds (TMFs) is a good option, as you need not worry if held until maturity, as are locked in at the yield at the time of investing.

 

Note on TMFs: These are passive debt funds that track an underlying bond index. Thus, the portfolio of such funds comprises bonds that are part of the underlying bond index, and these bonds have maturities in-line with the fund’s stated maturity. The bonds in the portfolio are held to maturity and all interest payments received during the holding period are reinvested in the fund. Thus, Target Maturity bond funds operate in an accrual mode like FMPs. However, unlike FMPs, TMFs are open-ended in nature and are offered either as target maturity debt index funds or target maturity bond ETFs. Thus, TMFs offer greater liquidity than FMPs.

TMFs are currently mandated to invest in government securities, PSU bonds, and SDLs (State Development Loans), thus, carrying lower default risk compared to other debt funds.

 

Author

Ajit Singh

Founder

Graded Financial Services | Quick Turtle | AskCred

Email: ajit@gradedfinancialservices.com

Shimmering Gold

 

Shimmering Gold 

After China, India is the second-biggest gold consumer in the world. However, India fulfills most of its gold demand through imports, and it is largely driven by the jewelry industry. India imported the highest quantity of gold in the last 10 years in 2021. The imports of gold in May 2022 jumped by almost nine times to $7.7 billion compared to a year ago.

However, the year 2022 has brought uncertainty to market players who are trying to assess the implication of higher interest rates on economic growth, in the backdrop of the Russia-Ukraine fight and the China- Taiwan conflict taking shape for war.

The gold price had a disappointing performance so far considering the strong uptrend in most commodities. Gold witnessed mixed trade in the first half of the year and has registered near 1% decline.

The central government decided to curb the import of the precious metal by hiking the import duty on bullion from 7.5% to 12.5% on 1^st July 2022 this year, amid the widening trade deficit, and the rupee taking nose-diving to Rs.80 to US$.  Gold also attracts a 2.5% Agriculture Infrastructure Development Cess (AIDC), adding up total duty of 15%. However, one may recall that last year the government cut the import tax to 7.5% to strengthen the domestic market. So, a hike of 7.5% on import duty can be termed as a reversal to maintain the balance. 

Considering that we meet domestic demand by way of gold import; such a step may lead to a proportionate rise in the price of domestic gold by around Rs.2000/10gm, factoring in international gold prices which are trading with a slightly negative bias. With domestic prices surging, demand is likely to take a hit at a time when the country is already grappling with high inflation.

Impact on Gold consumers of India:

Since the onset of the Coronavirus pandemic, gold prices escalated significantly in India. In March 2020, the gold rate was between Rs. 41,000 and Rs. 43,000 per 10 grams, making a historic high of Rs. 56,000 in August 2020. Currently, it is around Rs 53,300 at the time of writing this blog.

Higher prices due to duty hikes, slower economic activity, and tightening liquidity conditions due to interest rate hikes may impact gold demand significantly. The import duty hike will lead to a rise in the prices of gold jewelry in the country. With the GST rate hike on cut and polished diamonds from 0.25% to 1.5% from July 18, jewelry will most likely get dearer.
The move may affect exports too, which in May 2022  witnessed a year-on-year growth of 20% (Source: Gem and Jewelry Export Promotion Council).

Consumers consider gold as a hedge against inflation. However, this may not be the right time to invest in gold (SIP through gold ETF continues to be an exception), but, move the funds to be invested to sector-specific equities, Mutual Funds (via SIP route), and Corporate fixed deposits of AAA-rated companies which are giving attractive interest upto 7.40% p.a for 36month tenure.

 

Author

Thakur Ajit Singh

Co-Founder

Graded Financial Services | Quick Turtle | AskCred

Email: gradedfinserv@gmail.com

 

Invest Wise: Equity Market in 2nd half of the Year 2022

 

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 Invest Wise: Equity Market in 2^nd half of the Year 2022. 

Equity sentiment has been bearish, resulting in the worst annual start in the year 2022 for equities in 100 years.

The domestic equity market has witnessed a sharp correction in the first half of the year 2022. Benchmark indices BSE Sensex and Nifty50 have dropped more than 10% between January and June 2022. The fall in BSE midcap index has been steeper, and BSE smallcaps index has dropped over 16%. The Reuters poll of 30 equity strategists, conducted 13-24 May 2022, forecast the BSE Sensex to recoup less than half of its recent losses and gain only 3.2% to 56,000 by the end of 2022 from 54,288 points.

We have many challenges to tackle viz. high inflation, restoring the strength of Indian Rupee from its historical fall against US$, bridging the gap of burgeoning trade deficit, restoring the confidence of FPIs, and creating investment friendly atmosphere for FDI- which is a more stable and long-term investment.

Few more rate hikes are expected, making consumer loans dearer, which would adversely impact demand, in concurrence impacting GDP numbers. While we have yet no site on Russia – Ukraine war to end; China- Taiwan war is looming large, which if happens, would drift the already struggling world economy further away from revival.  Being a large importer of oil; the Indian economy is vulnerable to the recent increase in oil prices– which might take some more time to cool, thus, building further pressure on rising inflation, and depreciating Indian Currency.

Indian equities often underperform emerging markets historically in periods of high oil prices. Besides, market valuations are still higher than pre-pandemic levels. Valuations are susceptible to heightened global uncertainties. A combination of a quantitative tightening by a series of rate hikes, leading to a tighter liquidity situation, and commodity inflation would continue to exert pressure on asset prices.

Though the Foreign Portfolio Investment (FPI) outflows from India exceeded USD 30 billion in the first half of 2022, however, during that flight, the domestic investors did a balancing act by investing in Indian equities, showing their confidence in India’s growth story.

The data shows that Mutual Fund companies had 13.46 crore folios in June 2022 compared to 12.95 crore in March 2022, an increase of 51 lakh over the previous three months. The domestic MF industry's average AUM grew 19% to Rs 38.37 trn in FY22. Strong inflows into equity and hybrid schemes coupled with sustained inflows through the Systematic Investment Plan (SIP) contributed to the growth in assets. The assets under management (AUM) for SIP at the end of March 2022 were Rs 5,76,358.30 crore. showing that the retail investors kept investing despite the market's turbulence, to take advantage of Rupee Cost Averaging with the Power of Compounding.

India's GDP growth forecast is projected to be 7 % plus for the year, making it one of the fastest growing economies in the world. GST collections, Credit offtake, and Consumption numbers are showing an uptick. Therefore, the Indian stock market is likely to moderately stabilize in the second half of 2022. A mid-to-high single-digit growth rate is expected for S&P 500 earnings per share (EPS) in 2022, with J.P. Morgan’s estimates at $225 (vs. consensus $229.58).

It would be right to strategically buy the dips and allocate funds in select sectors like IT, banking, and consumer space where valuations have become attractive. Also, in these uncertain times, make Mutual Fund SIPs your preferred vehicle to take exposure in the equity market, by investing in a combination of Top Rated Mutual Fund schemes viz. Large Cap, Mid Cap, Small Cap, Multi-Cap, and Hybrid funds.

 

Author

Ajit Singh

Co-Founder

Graded Financial Services | Quick Turtle | AskCred

Email : gradedfinserv@gmail.com | Cell: 81698 10833