Components of the Indian Debt Market

As we saw in the previous article the Debt Market in India is growing at a rapid pace and is becoming increasingly interesting for Investors worldwide. Any market has a number of components or should I say participants. The Components of the Indian Debt Market include:

1. Investors - You and Me
2. Regulators
3. Debt Market Segments

The purpose of this article is to understand more about the Regulators of the Indian Debt Market and the broad classifications of the Instruments available in the Debt Market.

The Indian debt market can be broadly classified into four Segments. They are:

1. Money Market
2. Bank and Corporate Deposits Market
3. Government Securities Market
4. Corporate & PSU Bond Market

Let us now look at them one by one...

Money Market:

Money market refers to the market where the requirement or arrangement of funds is for a short-term. Short-term refers to a period of less than one year. As such money market instruments have a maturity of less than one year. The most active part of the money market is the market for inter-bank overnight (i.e. less than a day) call and term money between banks and institutions and repo transactions (banks' borrowing window from the RBI).

Some of the commonly used Money Market Instruments include:

1. Certificate of Deposits (CDs)
2. Commercial Papers (CPs)
3. Inter-Bank Participation Certificates
4. Inter Bank Term Money
5. Treasury Bills
6. Bill Rediscounting, Call / Notice / Term Money
etc.

Money market instruments are mainly used by Banks and other institutions to meet their short term cash requirements.

Bank and Corporate Deposits

Bank fixed deposits (FDs) are very common amongst the investors as a traditional investment avenue for decades. The tenure of bank fixed deposits range from 7 days to 10 years. Corporate deposits are nothing but fixed deposits where the issuer is a company or an institution other than a bank. Over here the interest rates vary depending upon the credit quality of the issuer.

Stories of Deposit Co.’s cheating investors by promising high returns have headlined numerous newspapers in India but still the Investor population of this country still continue to fall prey to false promises and greed. Any Debt Instrument that offers more than 10% returns has a high probability of going bust and you must never and I mean never trust them. Even if you are slightly tempted to try these out, limit your exposure to a few thousand rupees. Do not invest in lakhs and then feel for it in future!!!

Independent rating agencies assess the credit quality of the company and assign the rating indicative of the risk involved in the investment. Thus, higher the credit rating lower is the interest rate offered and vice-a-versa. However, sometimes companies raise money without securing a credit rating from independent rating agencies. In such cases companies often pay higher interest to attract investors. In such cases, Investors must be cautious and not invest too much money in a single company.

Government Securities Market

G-Secs or Government Securities are debt papers issued by the Government with a face value of a fixed denomination. In India, G-secs are issued by Government of India at face value of Rupees One Hundred in lieu of their borrowings from the market. These can be referred to as certificates issued by Government of India through the RBI acknowledging receipt of money in the form of debt, bearing a fixed coupon or interest rate (or otherwise) with interests payable semi-annually or otherwise and principal as per schedule, normally on due date of redemption.

Government Securities includes all Bonds, T-bills and instruments issued by the Central Government and State Government. These securities are normally referred to, as ‘gilt-edged’ as repayments of principal as well as interest are totally secured by sovereign guarantee and are 100% safe.

Corporate & PSU Bond Market

Corporate Bonds are issued by Public Sector Undertakings (PSUs) and private corporations in India. These bonds are issued for a wide range of tenors. The normal tenors range from 1 year to 15 years. As compared to Government Securities which are free of default risk; corporate bonds may turn out to be risky. This riskiness depends on the issuing company’s credit rating, the business into which the
company is in, the sector in which the company operates and the prevailing market conditions. As with corporate deposits, each issue comes with a Credit Rating which is assigned by a credit rating agency. This rating determines the risk involved and as always, higher the risk, higher will be the interest offered.

Regulators of the Indian Debt Market

Like any other market which needs to be regulated for its smooth and efficient functioning, the debt market in India is regulated by Reserve Bank of India (RBI) along with the Securities and Exchange Board of India (SEBI). Of the four major segments outlined just above, some are regulated by SEBI and some by RBI.

Reserve Bank of India

The RBI has the Money market and the G-Secs market under its purview. Apart from its regulatory role it also performs several other important functions such as managing the borrowing program of the Government of India, controlling inflation (by managing policy/interest rates in the country), ensuring adequate credit at reasonable costs to various sectors of the economy, managing the foreign exchange reserves of the country and ensuring a stable currency environment.

Moreover, the RBI controls the issuance of new banking licenses to banks. RBI also controls the manner in which various scheduled banks raise money from depositors. Further, it controls the deployment of money through its policy measures on Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), priority sector lending, export refinancing, guidelines on investment assets etc.

Securities and Exchanges Board of India

The SEBI acts as the regulator for the corporate debt market and the bond market wherein the entities raise money from the investors through a public issue. The regulation comprises of manner in which the money is raised and tries to ensure a fair play for the retail investors. It forces the issuer to make the retail investor aware of the risks inherent in the investment, through its disclosure norms. SEBI also regulates the Mutual Funds and the instruments in which these mutual funds can invest. Investment from Foreign Institutional Investors (FIIs) also falls under the SEBI’s scanner.

Other Regulators in the Indian Debt Market:

Apart from RBI and SEBI, there are several other regulators which are specific for different classes of investors such as the Central Provident Fund Commissioner and the Ministry of Labor to regulate the Provident Funds. Also, Religious and Charitable trusts are regulated by the respective Government of the state in which these trusts are located.

Invest Wisely in Bank Fixed Deposits

Investing in Bank Fixed Deposits is something that has been covered in this blog time and again. But, the purpose of this article is the direct result of a meeting I had with a friend during my most recent India Trip last week. To give you a hint – This article is about something we need to be very careful about while opening Bank Fixed Deposits.

What Happened in India?

I met a long-time friend just outside a Bank near my house and we went off to the nearby coffee shop for some chit chat. He had a receipt in his hand which looked like Fixed Deposit Receipts issued by the bank. Coincidentally I had just put up some Fixed Deposit in the same bank and the topic of our discussion touched upon the rate of interest. He had deposited Rs. 1,00,000/- at 7.25% per annum rate of interest for a period of 9 months and I had done Rs. 50,000/- for 1 year at the same rate.

I said, how come for two different tenures, the rate of interest is the same? Usually longer tenures have a higher interest rate and so we both went back to the Bank and asked the guy (Teller) at the counter for the Interest Rates list. He hesitated for just a quick second and then gave it to us.

The rates card looked as follows:

6 month 17 days to 9 month 15 days – 7.25% p.a
9 month 16 days – 8% p.a
9 month 17 days to 1 year – 7.25%

Both our initial reaction was what the ****!!!

Usually customers go to the bank with a predetermined duration in mind and the most common durations for the deposits is 6 months, 9 months, 1 year and so on. In this case my friend chose 9 months and I had chosen 1 year. The problem here is – neither of us cared to look at the rates card and if we had, we would’ve got an additional 0.75% rate of interest on our deposits.

What Went Wrong Here?

This situation can be attributed to 3 reasons which are as follows:

Reason 1: Neither of us cared to look at the interest rates card that the bank offered for various deposit periods.
Reason 2: The Interest Rate Card was not displayed prominently in the Bank. Though it was stuck to a pillar in some corner of the bank, it wasn’t in a place where every customer could easily see it.
Reason 3: The Teller did not suggest we look at the various deposit periods and choose the one that would best suit us.

In this case, the biggest blame lies on us because, it is our money and we should’ve been more prudent and wise in our decisions. From a banks perspective, the lesser interest they pay us, the better it is for them. From a teller’s perspective, he is only set targets on how much deposits he needs to mobilize and not the rate of interest. So, both reasons 2 & 3 are ethically Mistakes but Legally Not.

Remember the saying “If you don’t think about what is good for you, Nobody else will” This is totally apt with respect to all Money Related Transactions anywhere in the world.

My friend needed money for his son’s school fee next April, so he could’ve afforded to choose the 9 month 16 days scheme instead of the 9 month scheme he selected thereby getting an additional 0.75%.

He is going to get Rs. 5,437/- as Interest on his 1 lakh deposit at the end of 9 months while he could have gotten Rs. 6,333/- (Rs. 896/- more) for the same deposit amount if the deposit duration was an additional 16 days.

Lesson Learnt:

Always ask for the Rate of Interest offered by the bank for various deposit durations and choose what is best for you. Even if the bank has not displayed it prominently in their premises or if the Teller doesn’t offer you one when you inquire about Fixed deposits, you can DEMAND to see it before you invest your hard earned money.

Nobody and I mean NOBODY can deny you your right to take a look at the rate of interest offered by the bank for various deposit durations before you take your investment decision.

Alternately, you can check out the website of your respective banks and check out the interest rate beforehand and decide on the tenure before you actually visit the bank.

So, be cautious and make the best investment decision.

Verdict:

The whole idea of Fixed Income Investments is Safety of the money deposited & Guaranteed Returns. If the same amount will earn us a higher rate of interest, then we would rather choose that instead of something else.
After my experience as above, I did some digging and found that almost all banks had some sort of difference in rate of interest with some rare date combination like 444 days or 9 months and 16 days or something on those lines getting higher rate of interest than the regular 1 year or 2 year deposit durations. So, please be cautious and careful while making fixed deposit investments.

Happy Investing!!!

Where to Invest our Money Now?

With Stock Markets reeling under a lot of volatility, and the Indian Rupee depreciating against most major foreign currencies (esp against the US and Singapore Dollars) the outlook for the Indian Markets is not so green right now. As of now, the big question that is in peoples minds is “Where can I Invest my Money Now?“ Should I take a risk with the stock market or should I go for bank deposits? If you are someone who has had these questions pop-up in your mind over the past few months, this article is just for you...

Before We Begin

Before we begin answering the question, where to invest our money, we have to decide a few key aspects...

1. Decide How Much You Can Invest
2. Decide When you want the Money Back

Rationale: With the knowledge of when you want the money back, a wise decision can be taken

Point No. 1 is just a technicality to try to understand how much money we have to invest. It is not going to affect our investment decision much. But, Point No. 2 is going to be the key player in our decision.

The rest of this article is going to be about where to invest based on the timeframe as to when you want your money back. The details are split into four sections:

1. Ultra Short-Term (Less than 6 months)
2. Short-Term (6 months to 1 year)
3. Medium-Term (1 to 3 years)
4. Long-Term (More than 3 years)

Ultra Short-Term (Less than 6 months)

When you need your money back in the immediate future i.e., within the next 6 months, safety and security of the money invested takes highest priority. Lets say, you have some money that you have saved up for your Son’s Engineering College Admission in June of 2012 (It is January 2012 now) the most important consideration for you is, will the money be available for me when it is time to pay my Son’s college admission and fees. So, at such a scenario, investing in the stock market would be suicide and you may or may not be able to pay his fees using this money. So, the best Investment Options for an individual who plans on using the invested funds in the near future are:
1. Liquid Cash in your Savings Account – This is a wise choice if you need the money in a time period of less than 3 months. The whole hassle of opening a fixed deposit, breaking it a few days before you need the money, paying a penalty for premature withdrawal etc can be avoided. You can withdraw the money anytime you want. The Rate of Interest you earn is only going to be around 4%.

Justification: Even though your money is earning only 4% interest, your money is fully secure and available whenever you need it. So, this is the best choice for someone who needs cash in the immediate future.

2. Bank Fixed Deposits – This is a wise choice if you need the money in a time period of anywhere between 3 to 6 months. Your Money does not stay idle. With the current high interest rates offered by banks on fixed deposits, your money is going to earn a good income eventhough the duration is only around 6 months or lesser.

Justification: Your money is going to be safe because, banks in India are very safe and strictly regulated by the RBI. Moreover, your deposits will earn an interest of around 6-8% which is very good considering the kind of returns the stock market has offered over the past few years.

Short term (6 months to 1 year)

When you need your money in a time duration of between 6 months to 1 year, your choices of investment are a bit more diverse because, apart from capital preservation, the rate of returns the instrument earns is going to be a key criteria (unlike the ultra short-term where capital preservation was our main goal)

1. Fixed Income/Debt/Bond Mutual Funds – These days, there are a whole bunch of Debt and fixed income MF’s that are available in our market. These are MF’s that invest only on debt instruments (like bonds) and so, the principal invested is almost 100% safe. Moreover, since they invest in bonds from Corporations & other large organizations, the rate of returns is going to be greater than what is offered by Bank Fixed Deposits of equal tenure.

Justification: Even though these MF’s invest only in Fixed Income/Debt Instruments, default risk is a very real probability. But, the chances of that are less than 1 or 2%. Since as an investor you are bearing this 1 or 2% risk, the returns are usually an equivalent 1 to 2% higher than what Fixed Deposits yield us. So, this is a good choice for people planning to invest their money for a duration of between 6 to 12 months.

To know more about Debt Mutual Funds Click Here

2. Bank Fixed Deposits – The rates of interest offered by banks these days for deposits between 6 to 12 months timeframe are in the range of 6 to 10%. To add on, the deposits are 100% safe.

Justification: Safety, combined with good returns of around 8% makes these a very good choice. This is for the totally risk averse investor. If you are someone willing to take a small risk for a better reward, then option no.1 would be a better choice.

Medium term (1-3 years)

When you need money in a time duration of between 1 to 3 years, you have the opportunity to take a decent amount of risk to take advantage of the good returns offered by the Stock Market. Even if the markets remain volatile in the short term, they will recover and once they do, the returns will definitely be better than the other asset families.

1. Balanced Mutual Funds – These are Mutual Funds that Invest in both Debt and Equity Instruments. Well managed balanced funds move their assets between equities and debt to provide the best possible returns to the investor. They usually invest around 60% of their assets in debt instruments to provide capital preservation and invest the remaining 40% in the equity markets to provide far better returns than traditional debt instruments like bank deposits or debt MF’s.

Justification: Though Balanced MF’s have lost some value (In NAV) over the past year due to the turbulent markets, they havent done as bad as the Equity Diversified category of funds. This is because of the healthy allocation to debt instruments. So, if you are an investor with a medium term timeframe of 1 to 3 years, these would be a good bet. Even if the markets remain turbulent in the near-time future, it will definitely recover over the next few years and you can reap the benefits of the equity allocation of such funds.

Trivia: Last month we had taken a look at one of the best Balanced Mutual Funds in India "HDFC Prudence Mutual Fund". To know more about this fund Click Here

Long term (3 years or more)

When you are planning for a long term investment, you have the opportunity to take calculated risks to take advantage of the good returns offered by the Stock Market & Other Asset Classes. Even if the markets remain volatile in the short term, they will recover and once they do, the returns will definitely be better than the other asset families.

1. Diversified Equity Funds – These are Mutual Funds that invest directly in the Equity/Stock Markets. They invest predominantly in blue-chip or large cap stocks and also select a few good mid-cap or small-cap company’s to provide the best possible returns to the investor.

Justification: Diversified Equity MF’s have taken a significant beating over the past year due to the volatility in the stock markets. Experts suggest that, this is the best time to enter the market due to the cheap valuations. Fund Managers of well managed funds are using this opportunity to rejig their portfolio to best suit the investors. Considering our timeframe of 3 years or more, equities are our best bet and as always, no other asset class has outperformed equities on overall returns over the past decade. So, investing in Equities is a wise choice for the long-term investor.

2. Gold – Gold, the shining yellow metal has been increasing in value for the past few years and is expected to do so in the future as well. Though, the price may be volatile in the short term, overall the price of gold will only go upwards because of the supply-demand parity. So, gold too would be a good addition to your long term investment portfolio

Tip: If you decide on investing in Mutual Funds (Balanced or Equity Diversified) Systematic Investment Plans (SIP) are the best way to go. Since the markets are very volatile these days, investing regularly helps average out the high’s and low’s of the market and get the best returns

There have been numerous articles in my blog about investments & forming an investment portfolio. You can read them by clicking here

Happy Investing!!!