Mind your reinvestment risk in government bonds

admin — Mon, 01 Sep 2025 00:19:00 +0000

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Many appear to be interested in buying government bonds. You can buy such bonds by placing bids through your brokerage account. The intention to invest in such bonds is not surprising, given that they are credit-risk-free. In this article, we discuss the factors you must consider when investing in such bonds.

MAR risk

Picture this. You have lump-sum money, which, if invested at 6.5% per annum, can help you achieve a 10-year goal. So, you buy a 10-year government bond paying 6.50% per annum. The bond pays you interest every half year. The issue is that you must reinvest the interest received at 6.50% per annum for the remaining period of the goal. Otherwise, you are unlikely to accumulate the wealth required to achieve the goal. Why?

The required return of 6.5% is a (post-tax) compounded annual return, referred to as minimum acceptable return or MAR.

That means you must reinvest the interest every year at 6.5% per annum over the life of the goal to accumulate the required wealth. Government bonds do not compound interest income. You must find avenues to reinvestment the interest income. The risk is that the interest rate could dip in any period through the life of the bond (viz., reinvestment risk). That means you could fail to achieve the goal. Also, it is optimal to match the maturity of the bond with the time horizon for the life goal; you may not get the maturity appropriate for the life goal at the time you invest.

If you have a 10-year goal, there must be an auction of a 10-year bond at the time you invest. This makes investing for, say, 6, 7 or 8-year life goals difficult, as RBI may not auction bonds for such maturities. Note that interest income on government bonds is taxed at your marginal tax rate.

Conclusion

What about funds that invest in government bonds (gilt funds)? Your investment is based on the fund’s net asset value (NAV), which is the market value of the portfolio divided by the number of units. That means the fund’s NAV will decline when bonds held in the portfolio fall in price. Therefore, such investments are exposed to market risk.

Direct investment in government bonds does not have market risk; you can hold the bonds till maturity and get the par value regardless of the interest rate at that time.

(The author offers training programmes for individuals to manage their personal investments)

Published – September 01, 2025 05:49 am IST

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India To Be Part Of JPMorgan’s Emerging Markets Index. Here’s What It Means

admin — Fri, 22 Sep 2023 05:49:25 +0000

Currently, 23 Indian Government Bonds are index eligible, JPMorgan said.

Mumbai:

JPMorgan will include Indian government bonds in its Government Bond Index-Emerging Markets (GBI-EM) from June 2024, the Wall Street bank said on Friday.

The inclusion, a first for the country, could lead to billions of dollars of inflows into local currency-denominated government debt and bring down bond yields, while also providing some support for the rupee.

However, there is little direct impact expected on the equity markets.

WHAT PROMPTED THE INCLUSION?

The Indian government began discussing the inclusion of its securities in global indexes as far back as 2013. However, its restrictions on foreign investments in domestic debt held that back.

In April 2020, the Reserve Bank of India introduced a clutch of securities that were exempt from any foreign investment restrictions under a “fully accessible route” (FAR), making them eligible for inclusion in global indexes.

Currently, 23 Indian Government Bonds (IGBs) with a combined notional value of $330 billion are index eligible, JPMorgan said.

About 73% of benchmarked investors voted in favour of India’s inclusion, it said.

HOW LARGE WILL THE INFLOWS BE?

JPMorgan said Indian bonds will eventually hold a weight of 10% in its index, following 1% additions to its weightage each month from next June.

The inclusion could result in inflows of close to $24 billion over this 10-month period, analysts estimate.

This is significantly higher than the $3.5 billion invested by foreign investors in Indian debt so far this calendar year.

Foreign holdings of outstanding bonds could rise to 3.4% by April-May 2025, from 1.7% currently, analysts estimate.

WHAT IS THE IMPACT ON BOND YIELDS, BORROWING COSTS?

India’s fiscal deficit remains high at a targeted 5.9% of GDP for the year ending March 31, 2024, which will result in the government borrowing a record 15 trillion rupees (about $181 billion).

So far, banks, insurance companies and mutual funds have been the largest buyers of government debt. An additional source of funds will help cap bond yields and the government’s borrowing costs.

Traders estimate the benchmark bond yield will fall 10-15 basis points to 7% over the next few months.

Corporate borrowers will also benefit as their borrowing costs are benchmarked to government bonds.

However, increased foreign flows will also make the bond and currency markets more volatile and could push the government and central bank to intervene more actively.

WHAT DOES IT MEAN FOR THE RUPEE?

Larger debt inflows from next financial year will make it easier for India to finance its current account deficit and reduce the pressure on the rupee.

Index inclusion-related inflows of close to $24 billion will cover a material part of India’s $81 billion current account deficit, estimated for next financial by IDFC First Bank.

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Mind your reinvestment risk in government bonds

MAR risk

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India To Be Part Of JPMorgan’s Emerging Markets Index. Here’s What It Means