Invest in longer-term bond instruments as lending rates dips in India

By Vipin Agnihotri

Number of public and private sector banks in India has recently lower their lending rates for consumer borrowings. In my opinion, such a scenario gives investors who have invested in longer-term bond instruments a much-needed opportunity to make decent gains on their investments.

Point to be noted here is that even if Reserve Bank of India holds rates steady, as it is pretty much expected to do, given the increasing rate of inflation, they will still stand to make a neat packet. The pivotal factor here is that even if the inflation rate increases to 5 per cent, from about 4.07 per cent now, there will be enough liquidity in the system to keep growth on track.

As bond fund managers is all set to take a call on the interest rate movements and come up with a portfolio on the basis of their assessment, interest rates is going to play a pivotal role in determining the composition of paper in their funds. In the last two or three months, as interest rates have tended to harden, fund managers are focusing more on longer term bonds, essentially ones that mature in five, 10 or 15 years.

Generally speaking, bonds are of two types, namely, short-term and long-term. It is worth mentioning in this regard that the bonds with higher tenures always have coupon rates that progressively increase. On the other side of the coin, bonds with a maturity of 10 or more years have higher coupon rates to signify the uncertainty of the future as well as the risk of inflation.

The other significant factor on bond price is inflation. When the inflation rate dips bond prices rise even as coupon rates fall. In case if the inflation rate rises, the income from bonds will fail to compensate for the loss of buying power. It has been noticed that exchange rates also affect bond prices, as do international interest rates. In my opinion, money tends to get arbitraged between countries. Big institutions tend to make much of currency arbitrage, borrowing at one rate, earning interest at a higher rate

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