G-Sec Rises on Higher Inflation Expectation

India’s 10Y G-sec yield has risen to 6.221% from 5.826% in the past 20 days. The primary reason for this is the higher inflation expectation.

How does the increase in G-sec affect you?

• In simple words, NAV’s of your debt funds are inversely related to India’s 10Y G-sec yield. If Gsec increases, NAV’s fall. 
• Higher the duration of your debt fund, higher will be the drop and higher will be the volatility. 

The View forward:

• INDmoney has been sending continuous advisories to switch to low duration funds compared to high duration funds.
• 3 major factors that contribute to inflation are; Demand and Consumption, Sovereign debt and government spending and Currency. India’s debt is increasing and is at record levels. Currency has devalued significantly in the past few months. The demand and consumption are expected to increase as the country recovers from the COVID 19 pandemic.
• With high government expenditure, low revenue and a depreciating currency, India’s fiscal deficit is continuously increasing (the difference between total income and total expenditure)
• All these factors lead to a conclusion of high inflation.
• Once inflation increases, RBI would not be able to cut rates to promote growth. In fact, at some point, RBI would have no choice but to start increasing the rates slowly. 
• In the short term, we expect G-sec will remain highly volatile. 
• Monetary policy changes and fiscal measures are good measures to promote growth in the short term. However, in the long term, fundamental factors of the economy guide real growth and sustainability.

As stated in previous advisory notifications, the current economic and monetary conditions point to a bottoming of the current interest rate cycle and rates should increase in the long term (1-3 years)

This is exactly what happened post-2008 global recession. During the crisis, RBI reduced interest from 9% to 4.75% in a span of 1 year. Then as inflation picked up, rates started increasing.

INDmoney Recommendation:

Switch to low duration debt funds that have a 100% allocation to AAA-rated debt papers. Low duration will help you combat volatility much better and are likely to outperform long duration funds in the long term.

Find below a list of your high duration (duration > 3) debt funds. 

Note: Please keep in mind credit quality, taxation and exit load before switching.

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