G-Secs - A Better Alternative to Corporate Bonds

The global financial turmoil and credit crunch has impacted economies across continents. The theory of decoupling which had gained ground in the recent past has fallen flat as countries spanning the Americas, Euro zone, Middle East and Asia grapple with liquidity crunch and looming recession sparked off by the sub-prime crisis in the US. Emerging markets like India and China too are witnessing a slowdown which their respective governments are trying hard to counter with stimulus and fiscal packages. Given the current scenario, several Indian companies are faced with the scenario of deteriorating bottom line growth as financial credit becomes expensive and consumers adopt a cautious approach towards spending. This has increased the probability of possible downgrades in ratings for these corporate thereby influencing the prospects of their corporate bonds and similar instruments. Amidst this grim outlook, there is a strong need among investors for investment products which are relatively safe. In fact, today, a relatively safe and liquid investment is considered extremely important compared to returns or other parameters. In the ever changing dynamics of the market, certain investment avenues like G-Secs or Government Securities are therefore gaining ground for investors. income markets in India happens in G-Secs. Also with their flexibility to invest across maturities, GSecs provide investment opportunities both at the long and short end of curve depending on the interest rate outlook. A Gilt Fund is a mutual fund scheme that invests in different types of medium and long term government securities or G-Secs.

Do G-Secs score over other debt instruments? G-Secs score over other debt instruments like Corporate bonds for the following reasons: We expect a further slowdown in the Indian economy based on the IIP numbers in the last quarter and also the global recession. Slowdown has been observed in investment, consumption patterns and exports and all this after several fiscal measures have already been taken by the government. This slowdown has affected many industries. Profitability and NIMs are expected to come down in case of corporate, which in turn may lead to defaults, rollovers and downgrades. Average volumes of corporate bond market has been very low. Since the market doesnt have depth, not much trading is possible. In case of large redemptions it will be difficult to liquidate the portfolio. This type of liquidity risk is not present in case of government securities.

What are G-Secs? G-Secs or Gilts are issued by RBI on behalf of the Centre or State governments to finance deficits and public expenditure commitments. The tenure of GSecs ranges from one year to 30 years. Since they are issued by Central or State governments, G-Secs carry absolutely no default risk. Also the G-Sec market witnesses relative amount of liquidity. In fact as per data available*, 75% of the trading in fixed

The concerns of credit risk in the system have been reflected by the increase in investment of GOI securities by over 75% of incremental deposit. In the coming quarters as the economy slows down further the fear of credit risk could heighten as in the 2002 downturn and banks appetite for the safe government securities could rise resulting in pushing down the yields further.

G-Secs: A Better Alternative to Corporate Bonds

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Should one consider investing in G-Secs/ Gilt funds now? The bleak economic scenario coupled with falling inflation would prompt the market to factor further rate cuts, with the timing of the cuts being crucial going forward. With the repo rate at 5.5%, reverse repo at 4% and CRR at 5%, there may be significant room for further rate cuts. The reversal in global commodity prices and soft domestic demand are going to be the key drivers for the cuts. These rate

cuts could further drive down G-Sec yields which already touched new lows in Dec 08. In fact, there could be rate cuts of 150 to 200 bps from the current levels going forward which leaves scope for investors to benefit from G-Secs in the medium to long term. As such, investors could continue to get reasonable returns with low risk. Thus, from a portfolio diversification point of view too, Gilt Funds are an attractive proposition for any investor in the current scenario.

*Source: Fact book 2008, www.nseindia.com

G-Secs: A Better Alternative to Corporate Bonds

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