India's benchmark ten-year government bond yields have fallen 15 basis points (bps) since the beginning of April 2013. Yields on corporate bonds have declined in tandem with five- and ten-year benchmark AAA-rated papers falling by around 15 bps.
Falling bond yields lead to rise in price of fixed income securities and the holder of the security receives a total income from both the coupon rate as well as price appreciation.
To put it in perspective, a holder of a government bond with a coupon of 7.80 percent and a maturity of ten years, can see returns well in excess of 7.80 percent if bond yields fall. If the 7.80 percent ten-year government bond yield falls by 50 bps in one year, the holder of the bond will see gains of 7.80% + 3.25% = 11.05% over a year.
Investors tend to invest in fixed income securities when the outlook for interest rates is positive, i.e. when interest rates are expected to fall. The current economic environment in India is highly positive for interest rates as many factors are working towards a falling interest rate scenario.
The factors range from falling global commodity prices to expectations of rate cuts by the RBI in 2013-14. Worries on economic growth and weak corporate sales growth also add to expectations of a positive interest rate environment.
Oil prices are down close to 10 percent month to date and lower oil prices is expected to bring down the CAD (Current Account Deficit) from record highs of 6.7% seen in third quarter of fiscal 2012-13. Lower oil prices and lower CAD lead to inflation expectations coming off further from 40 month lows of 5.96% seen in March 2013.
RBI's latest survey on performance of private corporate business shows that sales growth slowed to post 2008 crisis low in the third quarter of 2012-13. India's GDP growth for the third quarter came in at decade lows of 4.5%. CRISIL has lowered India's growth forecast for fiscal 2013-14 from 6.4% to 6%.
The fall in oil prices coupled with inflation expectations trending down and domestic economy faltering will lead to rate cuts by the RBI.
The central bank is widely expected to cut rates by a minimum of 25bps in its 3 May 2013 annual policy and is also likely to cut rates throughout this fiscal as the economy struggles to stay afloat. RBI rate cuts is highly positive for bond yields, which are likely to trend down throughout this fiscal.
In a falling bond yield environment the best investments are in bonds and as a result of expected fall in interest rates, more and more investors are flocking to fixed income securities directly and indirectly.
Government bond auctions are seeing high bidding interest with bids going up to four times the auction size. Mutual funds schemes that invest in government and corporate bonds are seeing good inflows (assets have grown by at least ten times over the last one year). Gilt funds, income funds and dynamic bonds funds are the right funds to invest in to capture fall in interest rates.
Do not wait for more signals for interest rates to fall. Invest in fixed income now to take advantage of a falling interest rate scenario.
Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors