Debt and its relation to economy and the bank rates

  Debt and its relation to economy and the bank rates

Even though the entire focus of the public is always on equity, it is the debt market, which actually keeps the economy moving.

In simple terms, Debt is the money that is given by individual or an organization to another organization or the government.

This is termed in different ways, depending who the debt is been given to.

A private organization may take it form of commercial paper, debentures, or fix deposits, the government on the other hand may take it form of tax-free bonds, bank deposits, post office, schemes, PPF and it’s debt papers.

For the government, the papers, and the market is also referred to as GILT( at least in Indian context).

Needless to say, government or sovereign papers, have the highest safety, and while investing in the debt, it is the safety of capital that should be given the highest priority, instead of simply the returns.

We have seen with the case of Franklin india liquid fund and ultra short term fund. What happens in case of a default when we chase returns and ignore the quality of the debt papers.

Another very,Important aspect of debt, and its relation to the bank rates is, it’s inversely proportionality. Which means when the bank rates go up the return on the debt papers or the debt mutual funds falls.

As a corollary when bank rates fall down, the return on debt papers goes up.

THE IDEA OF WRITING THIS ARTICLE IS TO ELUCIDATE THIS IMPORTANT FUNCTIONALITY FOR NEAR FUTURE.

Even though the RBI has said that there is no indication of reducing the rates, but if the industry has to prosper, the bank rates and other connected rates like repo and reverse repo, will definitely come down, but when we cannot say.

Should this happen the returns from all the debt funds, including the GILT funds, will go up.

So what should be our strategy keeping this in view?

I have always maintained a ratio of 25% of the corpus in debt funds at all times. WheneverMy exposure to equity used to go above 75% are used to invest my salary in the debt funds.

Since it was very difficult for me to predict, what kind of debt funds will benefit, I used to spread my debt investments across ultra short term funds, credit risk funds, GILT funds and dynamic bond funds.

Invariably always I benefited immensely from the interest rate cycle.

Therefore, for those who have sufficient equity exposure, and are still earning, this could be a good time to start investing in the debt funds of the above categories or different categories as they feel comfortable.

Once again, I will request you to kindly do not fall for the highest return funds, but instead check the quality of the fund by checking the holding of the securities that they have. The papers or securities being held by the fund must be AAA RATING OR SOVEREIGN RATING (MEANS BE GOVERNMENT BACKED).

There is no need to shift your NRE fixed deposits to debt funds, and you should only invest the fresh earnings or proceeds from the sale of other assets. 

THE TAXATION ON DEBT FUNDS HAS CHANGED FROM FIRST APRIL 2023, AND AS SUCH DOES NOT COMPETE WITH THE RETURNS FROM RRE FIXED DEPOSITS, DUE TO THE TAX NATURE OF THE LATTER.

As I suggested in the opening lines, the industry depends upon debt, and therefore lower the rate of interest more profitable. It is for the industry and government to borrow money from the public.

So certainly when the interest rates will go down the stock market will also get a boost because of projected company profitability, and they will be in the equity returns also.

Therefore, it makes sense that you do not sell any equity to switch into the debt funds.

From the author : this article may be forwarded to your other colleagues on board  on leave or other friends and relatives, working assureso that everyone may benefit.