Tips for fixed income investors – Umesh Shanmugam

For the bond market, the important takeaway from the Budget is the proposed government borrowing programme for the next year as well as the efforts on fiscal consolidation. The former indicates the expected supply of government bonds in the market, which impacts existing bond investors.


The latter shows the government’s resolve to stitch together its stretched finances, which would indirectly influence the RBI’s monetary policy and the direction of interest rates. The bond market has reacted adversely to the slightly higher than expected borrowing (additional borrowing of Rs 50,000 crore) with the yield on the 10-year benchmark government bond jumping to 7.89%, up 11 basis points after the Budget.

Till now, the finance minister has demonstrated a firm commitment to fiscal discipline. This can be achieved by curbing expenditure and boosting revenues. However, it is a challenge to squeeze expenditure in a pre-election year, and that is reflected in this year’s Budget. A nearly 30% jump in planned expenditure has been proposed with a higher outlay for various social welfare schemes. Efforts have been made to augment revenues by widening the tax net, but the proposed measures are not substantial. The fiscal deficit numbers (gap between expenditure and income) turned out in line with market expectations.

The finance minister has set the fiscal deficit target at 4.8% of GDP for 2013-14, having contained the number to 5.2% for the current year. If he is indeed able to rein in the country’s stretched finances, the RBI may reciprocate by further softening its monetary stance, which will be a big positive for the bond market. Sujoy Das, director & head, fixed income, Religare Asset Management Company, says, “Even though the borrowing programme has emerged on the higher side, the bond market will take some comfort now that there is more certainty around the fiscal roadmap.”

What is on offer next year?

10-year bond yield

The Budget has not offered anything significant to the fixed income investor, but has not taken away anything either. Investors can take heart from a few individual announcements. Firstly, more tax-free bonds will be on offer next year. These bonds, introduced for the first time in 2011-12, were a breath of fresh air for the fixed income investor.

There was a fear that these bonds will be discontinued in the coming year for a variety of reasons, including a muted response from investors and improper use of the funds raised by issuing companies. Thankfully, the finance minister has spared the axe. This means investors can again look forward to safely putting away a chunk of their savings (up to Rs 10 lakh per issue for retail investors) in any of the forthcoming bond issues from government companies in 2013-14.

The finance minister has allowed for Rs 50,000 crore worth of issues, strictly based on need and the capacity to raise money in the market. Although these do not qualify for tax deduction on investment, the interest is tax-free, trumping most other options in the debt category on a post-tax basis. Those who subscribed to any of the issues last year stand to earn guaranteed, high post-tax return (around 8%) on their investment for as long as 10-15 years. These are especially tax-efficient for those in the 30% tax bracket, as interest from tax-free bonds (around 7.8% currently) comfortably beats post-tax return from fixed deposits (around 6.3% on a 9% fixed deposit).

 
Debt investors can also look forward to the launch of Inflation Indexed Bonds or Inflation Indexed National Security Certificates, which will essentially provide for protection of your savings from inflation. On theflipside, the Budget did not provide for re-introducing the infrastructure bonds, which used to provide an additional deduction of Rs 20,000 from your income under Section 80CCF, over and above the Rs 1 lakh limit under Section 80C.

What the numbers mean

Your strategy for next year

The RBI is likely to take comfort from the fiscal consolidation efforts of the government. Provided inflation does not rear its ugly head again in the coming months, most experts expect another round of rate cuts before the end of the year. “We expect the RBI to cut repo rate by 50-75 basis points over this calendar year,” says Joydeep Sen, senior vice-president, advisory desk, fixed income, BNP Paribas Wealth Management. Lakshmi Iyer, head of fixed income, Kotak Mutual Fund, is not worried by the spike in bond yields. “This appears to be another knee-jerk reaction typically seen on Budget day. We are likely to see more rate cuts in the coming months, which will drive yields lower,” she says.

In a falling rate scenario, investors should latch on to duration funds, or debt funds holding long-term bonds. “Investors with risk appetite and looking for a term of at least one year can invest in long-term income and gilt funds. However, if your investment horizon is shorter, say six months to one year, stick to short-term bond funds,” adds Sen. Iyer adds that investors can use the sudden spike in yields as an opportunity to enter long-term funds.