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Corporate tax cut: your debt mutual funds may give you lower returns

The stock market may be celebrating the corporate tax cut, but the debt market participants are nervous about how the government is going to bridge the deficit

, ET Online|
Sep 23, 2019, 03.12 PM IST
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The stock market may be celebrating the corporate tax cut, but the debt market participants are nervous about how the government is going to bridge the deficit. Reflecting the anxiety, the 10-year benchmark bond yield jumped from 6.64 per cent to 6.79 per cent in a day after finance minister, Nirmala Sitharaman, announced a cut in corporate taxes.

This is bad news for debt mutual fund investors, especially those investing in long duration bond funds and gilt funds. Debt mutual fund managers believe that if the spike continues, bond funds might be hit in the coming time. Bond yields and prices move in opposite directions. When the bond yield goes up, the bond prices and NAVs of debt schemes fall.

The fiscal deficit estimate has gone up from 3.3 per cent to 3.70-4.0 per cent this financial year. Debt mutual fund managers believe that liquidity is a primary concern in the market at this point. “We have seen enough liquidity in the market in the first half of the year, but at this point the liquidity is a concern. The fiscal deficit projection has increased. The pressure on the bond market is in anticipation of a rise in market borrowings,” says Mahendra Jajoo, Head-fixed income, Mirae Asset.

Finance minister on Friday announced to cut the corporate tax rate for domestic businesses to 25.17 per cent, including surcharges, and will be applicable to companies not availing incentives. The current corporate tax rate is 30 per cent. The finance minister also said that the revenue loss to the exchequer will be Rs 1.45 trillion in 2019-20.

Experts believe that this spike in yields can be controlled by a surge in liquidity. “We believe that a liquidity infusion drive might help the bond market at this point. Open market operations have solved the liquidity issues in the market earlier also. However, there is no clarity on when RBI will come up with another OMO,” says Kumaresh Ramakrishnan, head-fixed income, PGIM India Mutual Fund.

The market is also concerned about the future of rate cuts by RBI. Mutual fund managers believe that though there is still room for more rate cuts in the system, the timing will be crucial. “I believe there is room for more rate cuts, but the rate cuts till now haven’t helped the system. We have seen around seven rate cuts till now, but they haven’t been transmitted,” says Mahendra Jajoo. He adds that, “We will have to look at how inflation numbers behave after the announcement. If the CPI remains benign, we might see more rate cuts,” says Mahendra Jajoo.

Debt mutual fund managers believe that if the scenario remains the same, bond funds might feel the pressure. The worst hit will be long duration bond funds and gilt funds. “The longer end of the yield curve will be under pressure. Long duration bond funds have seen a good rally in the last one year. However, this is the thing; the rally can get over any time. Debt mutual fund investors who don’t want to time the market and want to avoid such sudden volatility should stick to short to medium duration bond funds,” says Kumaresh Ramakrishnan.

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