With interest rate rising, is it right time to invest in G-secs?

Retail investors now have the opportunity to invest in government securities that was so far the domain of institutional investors such as banks, mutual funds and insurance companies.

Within a week of Union finance minister Nirmala Sitharaman announcing in her Budget speech that the market participation in the debt market would be deepened, the Reserve Bank of India (RBI) took steps to enable retail investors buy government securities online.

RBI Governor Shaktikanta Das has already described the measure as a “major structural reform”.

Indeed it is, but the moot point is, with yields on benchmark bonds rising and apparent indications of the interest rate cycle bottoming out on the horizon, is this the opportune moment for retail investors to step into the government securities market?

The key to this question lies in the movement of interest rates.

The prices of bonds, or government securities, is inversely related to interest rates. If the interest rates fall, bond prices rise and when interest rates rise, bond prices fall.

The rate of interest a bond carries is called the coupon rate and is fixed when the instrument is issued. Naturally when interest rates rise above the coupon rate, the instrument becomes unattractive driving down the demand and, therefore, their price. The reverse is also true – when interest rates in the market falls below the coupon rate, the bond that carries a higher interest rate looks attractive to investors leading to a rise in the price of these bonds.

While bonds are in most cases for the long-term investor, it does not seem to be appropriate time to invite retail participation in a market where prices are falling.

Significantly, when interest rates rise the NAV of funds that invest in government securities also fall, which is happening right now.

In India, the benchmark 10-year government securities were giving a yield of 5.90-5.95% in end-February early-March. Now it has moved past 6.3%. The yields of securities of other durations are also moving up. Experts are of the opinion that the rising yields can eventually see a rise in interest rates.

Interestingly in Q3, both State Bank of India and Canara Bank have nudged up interest rates on certain Fixed Deposits in January and some experts are thinking of interest rates bottoming out in the country.

In India, the fixed income government securities constitute an area where retail investors could not step in.

“This is perhaps not the opportune moment for the retail investor to sink his funds. In other words, he might not be encouraged to invest in a market where the prices of the assets are falling. This is all the more applicable when he is investing for the first time,” said Nilanjan Dey, director, Wishlist Capital Services.

“Allowing a window for retail participation in the G Sec market is indeed a major step. But one might have to wait for some time – maybe a couple of years – before retail investors start flowing in.”

Prasunjit Mukherjee, chief ideator, myplexus.com, felt the step had no relation with what the common investor wants.

“I never see any good in trying to open a window for debt trading for retail investors. It is better for mutual funds to have fixed maturity plan gilts over various time frames. It is cheaper and easier,” he said.

Inflation, too, is a cause for concern for Reserve Bank of India. CPI inflation is towards the upper level of the tolerance band which is 4% (+/-2%). If it rises close to, or crosses, the 6% mark, the central bank may nudge the interest rates upwards to rein it in. As the economy grows out of the pandemic-triggered territory, inflation might be a real concern, said experts.

That’s another factor that might negatively affect the price of bonds.