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Tight monetary policy Policy - Debt Instruments good


   The monetary policy of the Reserve Bank of India (RBI) is used to control money supply in the economy which in turn affects the interest rates on loans. The major monetary policy actions include increasing the key interest rates and changing the availability of free money with banks using the cash reserve ratio. These actions directly and indirectly influence aggregate demand. Therefore, they are used as tools to stimulate or control aggregate demand in the economy.


   In India, the interest rates have been going up slowly over the last one year as the RBI is tightening the monetary policy. The inflation rate has been ruling high since the last couple of years. The RBI is using the monetary policy to control aggregate demand, to bring the inflation rate down. Due to the rising interest rates, debt instruments are finding favour as their yields have gone up due to the interest rates hardening. The rates on bank fixed deposits have gone up to almost the 10 percent levels. Therefore, risk-averse investors are increasingly looking at increasing their portfolio allocation to debt based instruments.


   These are some debt-based instruments in the market:

Saving schemes    

These schemes are completely risk-free. They are mainly offered by government agencies and banking institutions. Some examples are bank deposits, Public Provident Fund (PPF), National Savings Certificate (NSC) etc. The returns net of tax are attractive in most of these schemes as they offer tax benefits.


   However, most of these schemes are not very attractive in terms of liquidity. Usually, they come with a long-term lock-in period.

Debt mutual funds    

Debt mutual funds invest the corpus in risk-free government securities and top rated corporate deposits, and offer slightly higher returns than bank deposits. There are various flavours in instruments available in the debt mutual fund category. Liquid mutual funds are good for short-term needs, where you need to park money for a short duration.


   You can also look at investments in debt funds to save on tax.

Hybrid products    

There are many hybrid products on offer in the market. These products offer a balance of risk and returns. Some of these instruments offer a fixed percentage of allocation towards debt and the remaining is put in equity, with the option to change the allocation based on your needs and market conditions. Also, there are some innovative products in the hybrid category that guarantee the principal amount. However, the returns are linked to some equity-based milestones such as the Nifty index, returns from top five companies etc.


   These products are based on the derivatives market. You should understand the various terms and conditions before committing a large amount to these instruments.

Time to review portfolio    

Debt instruments are looking more attractive in the current market conditions as their yields have gone up due to the interest rates hardening. Although the nominal returns on various debt-based instruments have gone up significantly over the last few months (especially on short and medium-term schemes), the real returns (returns after factoring in the rate of inflation) still work out to be quite low.


   On the other hand, volatility and stretched valuations in equity and equity-based instruments have tilted the risk-returns equation towards risk, and the real returns (inflation adjusted yield) have come down on these instruments as well. Therefore, it is important for you to review various aspects of your investment requirement (objective, horizon, risk appetite etc) and take a decision on investing to ensure a balance between risk and returns.

 

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