Is it possible to get a 10% return in the Indian bond market
Forex Hedging |Â
Uploaded on: 1st February 2021
Under the current scenario in the Indian banking system, Fixed Deposit rates vary between 3% and 7%. It is quite obvious that FD rates have collapsed. This means that Fixed Income investment is in search of better yields.
India is in a very unique position to offer such high yields. Among the G20 countries, high yielders include Argentine, China, Indonesia, Mexico, Russia, and Turkey. Among these, Argentina suffers and Turkey suffers from currency crises. Russia has historically not been a favorable investment option due to the political scenario in the country. Indonesia and Mexico do not offer enough opportunities due to the size of their economies. That leaves China and India. China, as you are aware, is being shunned due to the COVID-19 crisis, and there is growing distrust within the developed world.
All these conditions together put India in the ideal position. India has cheap labor, favorable political support for large-scale investment, and a growing population. This attractiveness for India will only continue as divestment in China becomes the norm and world capital flows need some place else to go.
India has an extremely steep yield curve, with a 2.5% spread between the 1Y and 10Y sovereign bond yields.
The major pros to investing in bonds instead of fixed deposits are that you can exit a bond instrument at any time, provided there is sufficient liquidity in the market. On top of that, a change of 1 basis point, affects the bond price by 7 bps.
Let’s take an example to make things simpler. The modified duration for a 10Y bond with a 6.2% semiannual coupon is 7.20. Now if you decide to exit after one year of holding the bond, and the yield at that time is 5.5%, then due to the increase in the price of the bond, you would stand to make an overall profit of 9.10%. In a similar fashion, the table below explains all the various scenarios that can take place, and what the return percentage in each scenario would be.
| Remaining Yield Movement | 1Y Exit | 2Y Exit | 3Y Exit | 5Y Exit | 10Y Exit |
| 4.0% | 20.35% | 12.10% | 9.48% | 7.43% | 5.95% |
| 4.5% | 16.43% | 10.47% | 8.56% | 7.05% | 5.95% |
| 5.0% | 12.69% | 8.88% | 7.65% | 6.67% | 5.95% |
| 5.5% | 9.10% | 7.34% | 6.76% | 6.29% | 5.95% |
| 6.0% | 5.67% | 5.83% | 5.88% | 5.92% | 5.95% |
| 6.5% | 2.38% | 4.35% | 5.02% | 5.55% | 5.95% |
| 7.0% | -0.77% | 2.92% | 4.18% | 5.19% | 5.95% |
The capital markets in India are still growing and have a very long way to go. Investment in fixed income through Mutual funds is also possible now. This involves the trading of long duration, constant maturity funds in government bonds.
The overall outlook is positive and we expect that it is possible to achieve a return of over 10% in the Indian bond markets.