Bonds and fixed return instruments get only a fraction of the attention of stock markets. However, of late there is a lot of discussion on interest rates especially with the successive rise in their rates. The outlook for interest rates in India is dominated by two factors–expectations on global yields and domestic macro environment.
But first, why is interest rate tinkered with? The inflation rate based on the consumer price index has been rising in recent months from 3% in early 2004 to as high as 7% a few months ago. Likewise the wholesale price index also accelerated from under 3% to close to 6%. This sharp rise in inflation is one of the main factors that have led to a hike in interest rates. Every time the rate is hiked, the cost of borrowing goes up, and is felt by many, especially those who are servicing a home loan. Though the borrower is a loser, for many the impact of a rise in interest rate can be felt by the check on inflation, retaining your spending power or increasing it.
Currently the global scenario remains benign with major central banks at the fag end of their rate tightening cycle. In the Indian context we are if not on the peakend of the rising cycle, we are close enough to that level.
Medium-long end bonds (longer than 10 years) are supported by increased demand from fast-growing banks and insurance sector. With government borrowing programme remaining contained due to buoyant revenues, reduced supply of bond further supports the medium-long end of the curve. Thus, medium-long bonds are likely to remain range bound in 8-8.25%. Further interest rate tightening would likely have most impact on the short-term rates with long end remaining stable in such a scenario.
In the current scenario the debt and fixed return instruments look very attractive and interest rates on bank deposits are still above 10% is indicative of good times for those who favour a fixed income portfolio. Needless to add, investors should consider respective risk-profiling and investment horizon.
(By Mahendra Jajoo, Head, Fixed Income & Structured Products, ABN Amro MF)
