What is the outlook for debt market instruments in 2017?

What will be the outlook for debt products in 2017? Normally, any year that has been great for equities has not exactly been too great for debt. However, 2017 could be a year with sufficient opportunities to make profits in debt instruments too…

Be careful on FDs… 

According to a recent survey of saving and investing habits in India, nearly 60% of Indian household assets are held in physical form like land and gold. The balance 40% is held in the form of financial assets, which is again dominated by bank FDs. Bank FDs have been a traditional favorite among the conservative investors and senior citizens for the safety and security that it offers. But, in year 2017 it could be a bad choice. Firstly, with banks flush with deposits and on a rate cutting spree, you could see FD rates also fall rapidly. That will mean that returns on bank FDs could be squeezed further. Unlike bonds and debt mutual funds, bank FDs only benefit from the interest payout. They do not benefit from price movements. Thirdly, FDs are very inefficient in tax terms. For example, a 7% FD will give a post tax return of just 4.9% after considering 30% peak tax. That hardly covers the rate of inflation. With the PM prescribing FD rate protection for senior citizens, it is obvious that general FD rates will be increasingly aligned to the market. That is not great news for FDs in a falling interest rate scenario!

Debt Funds could be the answer… 

With inflation headed lower and yields also looking to fall further, debt funds may be the instrument to watch out for. Debt funds, as the name suggests, invest in a portfolio of bonds and long dated debt instruments. Gilt funds are most vulnerable to changes in interest rates as they invest in government securities which have zero default risk. With inflation likely to remain weak and surplus liquidity with banks leading to greater transmission of rate cuts, the signal is of lower yields on bonds. The fall in yields comes with capital appreciation and debt funds are normally the biggest beneficiaries. In fact, in the coming year debt funds could be a much better choice compared to bank FDs as it will help you participate in falling yields and are also more tax-efficient. 

How will FPI flows pan out?

Foreign portfolio investor (FPI) flows are critical to debt markets. Normally any risk-off trade means an outflow of money from Indian debt into safer economies like the US and Germany. With the yield spread at comfortable levels and the INR fairly stable versus the dollar, we do not see a major risk to FPI outflows from debt in the year 2017. In fact, year 2017 could see the debt market outflows of 2016 largely reversed. That may be the big news for debt markets in year 2017! ©

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