One happy side-effect of demonetisation is in the engendering of windfall profits in 100% Indian Debt Mutual Funds. The Economic Times called it an injection of “adrenaline”.

Many of these returned 30%, annualised in funds holding medium-term securities, with maturities in one to three years, and even some maturing in three to five years. The Gilt Funds holding 100% government paper, some with even longer durations, did just as well.

Others, shorter-term, bonds, debentures, government securities for periods ranging from three months to one year also performed. And the absolutely “liquid” funds that are used to park overnight funds etc., returned an unprecedented 12% in November 2016.

Going forward, RBI Governor Urjit Patel chose not to reduce the repo rates in early December, against expectations, but reportedly fearing inflation topping the target of 5%. Even so, the debt funds at the top-end are still expected to return 25% annualised for December 2016.

The RBI Governor did cut 25 bps in September soon after taking over, but the high street banks were slow in passing on benefits to their customer borrowers. This might have influenced him this time. Because now, with such a wealth of money, banks are cutting fixed deposit rates on their own, if not the lending rates too. Bank fixed deposit interest rates are bound to see further declines in the near term.

Cuts in the repo rate of 25 to 50 bps are expected early in 2017. This, as a measure to revive demand for loans, if the banks haven’t managed to pump up their portfolios at self-motivated and cheaper rates of interest.


Reports suggest that there may be as much as Rs 20 lakh crore out there, the excess clandestinely issued by previous governments, “off the books”. If this is so, it would raise a number of serious questions with regard to the authenticity of the country’s erstwhile fiscal management. 

The banks have no reason to hoard money now, nor refuse to lend to good prospects, because their NPAs and bad debts, all less than 10% of assets anyway, are not nearly as burdensome. Also, to date, over Rs 12 lakh crore of the estimated cash held in Rs 500 and Rs 1,000 currency notes has now come in. Some of the sudden excess liquidity has also been sucked up by the RBI via raised CRRs (cash reserve ratios) towards system stability.

With a slack loan portfolio, however, banks have been buying government securities “aggressively”, also contributing to a rise in bond prices. The benchmark ten-year yield, for example, came down to 6.43% by 21 November, from 6.80% on 8 November. The yield on three-month bonds also declined from 6.40% on 8 November, to 5.94% on 21 November.

Long-term bond holders gained 2.8% in days, the amount normally earned in three-four months. Long-term Gilt funds too garnered more than 3% in absolute returns in November.

The pace of depositing the old cash has now slowed considerably, suggesting it might run out soon. If it does, any amount short of the estimated money in circulation, even if it is just Rs 1 lakh crore, will be a bonanza to the RBI and the government.

So how much will be in by yearend? And then, how much more directly to the RBI by March-end 2017?

How will the budget announcements of 1 February 2017, the Finance Minister hinting at a reduction in direct taxes affect the equity and debt markets?

The Indian equity market has been hit since Trump’s election and the demonetisation. But the debt market seems detached from the tumultuous front-page goings on and confident of the future trends, both based on the fundamentals of the economy and the massive pseudo-recapitalisation of the banks. Of course, deposits into the bank by customers are not the same as equity injections by the promoters and the government, but still.

There have been scattered reports of even more demonetised currency notes being out there than the current government and system is aware of. Figures of a ceiling of 15 to 17 lakh crore have been mentioned, which constitute 86-87% of the currency in circulation. But the vagueness suggests nobody quite knows for sure. And now reports suggest that there may be as much as Rs 20 lakh crore out there, the excess clandestinely issued by previous governments, “off the books”. If this is so, it would raise a number of serious questions with regard to the authenticity of the country’s erstwhile fiscal management. And produce the need to come up with unprecedented confidence-building remedies.

Meanwhile, some Rs 19,000 crore of the smart money has been invested into debt mutual funds in November, and more retail, domestic institutional and foreign institutional investment is bound to follow. This, to take advantage of the mouth-watering returns at minimal risk and volatility compared to bank FDs or even other debt markets around the globe.

However, over Rs 17,000 crore in FII investment, from a total of over Rs 30,000 crore of their money, has departed our debt markets simultaneously. This is a safe-haven manoeuvre, versus the risks of emerging markets (EMs) and might continue, particularly from the higher risk equity markets in India, which have also seen steady outflows ever since the steady US economic recovery. This is spurred by the third modest increase of 25bps effected by the US Federal Reserve Bank recently, bringing their interest rate up to a magnificent 0.75% p.a., after nearly a decade of near zero. Also, the decisive election of billionaire businessman Donald Trump has set off a boom in the US stock market, if not their debt market, to the same extent. But since the US stock and debt markets are the biggest in the world, at many multiples of ours, every blip makes a volume difference. But still, the returns in our Indian debt market now should entice FII money to return, perhaps in larger absolute terms, if not in EM allocation percentages, than before. 

Some would argue, however, that this kind of outsized return is a happy aberration that cannot be sustained. And yet, some fundamentals are changing that may keep the good times going for at least six months going forward.

Demand for debt instruments from investors will drive up prices. Offtake by the government for development/infrastructure projects and welfare is likely to increase. The private housing loan providers that have been languishing because of high rates are likely to see a gradual uptick as they shake off the housing sector recession. Other private sector borrowing too may help buoyancy. 

Banks may become far more aggressive in the effort to recover their non-performing assets (NPAs), including the liquidating of defaulter collateral in their possession.

And lastly, the drive towards a digitised and much more cashless economy may be succeeding, with a slew of follow up measures and fine tuning of alternative delivery systems.

Items like the value of the currency against the US dollar, foreign currency reserves, expectedly renewed growth, lowering inflation, fiscal and current account deficits, reduced counterfeiting are also of benefit.

In the absence of the major headwinds from higher petroleum product prices in the near future, this benign scenario for the debt funds may continue.

In the context of most household savings ranging from 94% to 98% of the total, always steering clear of both the stock and debt markets, the time may have come to make a change.

The lamentation on declining bank fixed deposit rates is now useless for the medium term.

The open-ended debt funds are just as safe and liquid as the banks. An investor can deposit or withdraw funds on any working day, receiving proceeds into his or her bank account within three working days. While the current tax treatment is at the marginal rate for three years followed by 20% and indexed, the returns justify the effort, even if they settle down in the long run to the 8% to 10% per annum range as before.

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