Go Buy Bonds, The RBI Cannot Be More Direct Than This

Go Buy Bonds, The RBI Cannot Be More Direct Than This

 

It cannot get more clear than this.

 

Especially when it comes from someone who has an A+ report card.

 

We are talking about Shaktikanta Das, the governor of the Reserve Bank of India. Das received A+ grade in the Global Finance Central Banker Report Cards 2023.

 

Speaking at the World Economic Forum at Davos in Switzerland recently, Das said RBI expects average Consumer Price Index (CPI) inflation of 4.5% for the next year, with a commitment to reaching the 4% threshold at the earliest.

 

For perspective, India's retail inflation, which the CPI measures, surged to 5.69% in December 2023 from 5.55% % in November 2023, according to the latest data from the Ministry Of Statistics and Programme Implementation. The lowest CPI in 2023 was in May at 4.25%.

 

This bodes well for investors who slowly start increasing their exposure to bonds.

 

Inflation-Bonds Relationship

 

When inflation is expected to fall, investing in bonds becomes a strategically sound decision for several reasons.

 

Firstly, falling inflation often leads central banks, like the RBI, to cut interest rates to stimulate economic growth.

 

When interest rates drop, the prices of existing bonds typically rise as they offer higher yields than new bonds issued at the new, lower rates.

 

This potential for capital appreciation makes bonds attractive to investors.

 

Secondly, lower inflation preserves the purchasing power of the fixed income bonds provide.

 

The real return of bonds – the nominal return adjusted for inflation – becomes more favourable in a low-inflation environment. This is particularly beneficial for investors seeking steady, predictable income streams.

 

Moreover, bonds are generally considered less risky than equities, especially government bonds, backed by the sovereign guarantee.

 

In times of economic uncertainty or transition, such as a shift from higher to lower inflation, bonds' stability and lower volatility make them an appealing choice for risk-averse investors.

 

This shift towards bonds can be prudent to safeguard investments against market volatility while still achieving reasonable returns.

 

Interest Rate Outlook

 

The RBI has held the key policy rate steady at 6.50%, but the median forecasts suggest that rates have peaked and will likely remain stable in the near term.

 

However, there's a growing anticipation of a downward trend. Projections indicate a gradual reduction in the repo rate, contingent upon the decline in inflation.

 

Many economists estimate a fall in Consumer Price Inflation to 4.6% in FY25 from 5.4% in FY24, influenced mainly by lower food inflation.

 

For context, India's wholesale inflation rose to a nine-month high in December to 0.73% from 0.26% in November, primarily due to an increase in prices of food items.

 

Das said government measures with supply-side interventions have played a key role in handling food price shocks and will lead to a fall in prices.

 

Economists expect rate cuts could start with a 50 bps fall in policy rates in FY25, beginning October.

 

Bonds as a Strategic Investment

 

This expected fall in interest rates signals an opportune moment for investors to consider fixed-income assets like bonds.

 

The anticipated stability and potential decline in rates render bonds an attractive option for those looking to balance or diversify their portfolios. When interest rates fall, bond prices typically rise, as investors rush to secure yields, making it a strategic time to invest in bonds.

 

Smart Investors Load Up On Bonds

 

The National Pension System (NPS) is increasingly channelling funds into government bonds.

 

 This shift is driven not only by the default retirement plans of state employees but also by a cautious approach towards equities, which currently show steep valuations and are jittery in the midst of the earnings season.

 

The RBI's latest data indicates a significant increase in pension funds' investment in government bonds – a jump from 3.50% to 4.32% of the outstanding stock, equating to about ₹4.48 lakh crore in government bonds as of September's quarter-end.

 

What This Means for Investors

 

The growth in government bond holdings by pension funds has outpaced the overall assets under management growth of the NPS.

 

This trend signals a growing confidence in government bonds, drawn by their reputation as a dependable and rewarding investment. For individual investors, this translates into a promising opportunity to invest in bonds, especially in a climate of falling interest rates.

 

In light of the RBI governor’s comments on the expected fall in inflation control and the consequent anticipation of a reduction in interest rates, bonds emerge as a compelling component of a diversified investment portfolio.

 

Investors should consider the benefits of fixed-income assets, particularly government bonds, in the context of the current economic environment and future projections.

 

A balanced and informed approach is key to navigating these changing market dynamics.We are sure you enjoyed reading this article.

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