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5 Dec 2020

Bond strategy to beat inflation as RBI keeps interest rates low amid high inflation

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RBI in its policy review statement on the 4th of December 2020 said that inflation pressures are rising and inflation is likely to be higher at around 5% levels at least until September 2021. CPI inflation is running at 7.6% at present and various factors including higher spending by the government and lack of infrastructure creation has created a demand supply mismatch with demand outstripping supply.

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Arjun Parthasarathy

Why Fixed Income Investors are getting hurt?
RBI in its policy review statement on the 4th of December 2020 said that inflation pressures are rising and inflation is likely to be higher at around 5% levels at least until September 2021. CPI inflation is running at 7.6% at present and various factors including higher spending by the government and lack of infrastructure creation has created a demand supply mismatch with demand outstripping supply.
However, despite higher inflation, RBI is intent on keeping interest rates low to help government borrow to spend on growth. This policy of low rates, high inflation is impacting fixed income investors the most as earnings on deposits and other fixed income instruments is far lower than inflation.

 

How to earn returns that beat inflation?
Given that earnings from interest rate products are lower than inflation, the question constantly asked is how to earn returns that are higher than inflation. This involves risk that many investors may not have the appetite. Investing in longer maturity bonds or in bonds of issuers where credit risk is high is not a good option for low risk investors. Equities may be too volatile and real estate is too expensive and illiquid. Gold prices are at record highs and from here risk may be higher.
There is no safe and sure way to beat inflation but a good bond strategy will help.

 

Bond strategy to beat inflation
Inflation is currently at levels of over 7% and is forecast to come down to around 5% in the next 7 months. Average inflation will be around 6% or higher. Hence, bonds that yield returns of over 6% can help negate inflation to some extent. However, government and corporate bonds that yield over 6% are either long maturity bonds, where prices are very volatile and when interest rates rise, capital is lost on selling the bond, or carry higher credit risk where the fundamnetals of the bond issuer are low and can deteriorate further.
Identify bonds that yield over 6% but have short maturity and are of good quality to beat inflation as then money can be reinvested at higher yields on maturity of the bonds.

 

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