Inflation in itself does not impact the debt fund to invest. It is the change in policy rates, influenced by changes in inflation, which impacts these investments. The central bank of a country, like RBI in India, is responsible for making changes to policy rates. It’s part of its monetary policy. You can read more about how RBI’s policies affect your investments,
If inflation is not within a comfortable range, it may make the RBI act. One important thing to keep in mind is that the interest rates and bond prices are inversely correlated; if rates rise, prices fall.
If inflation falls below the comfort level, the RBI has to lower its interest rates. By doing that, it increases the supply of money in the financial system. This increased supply allows banks and financial institutions to lend more to people and companies at cheaper rates as more money is chasing less demand. Once demand increases, inflation increases to the desired level. On the other hand, if inflation is spiralling, the RBI raises rates which decreases the money supply and suppresses demand, thus bringing inflation back to its desirable range.
Thus, when interest rates rise because of higher inflation, bond prices fall, resulting in a decline in the value of the debt funds. Conversely, a decline in interest rates may be beneficial for the debt fund managers in India who may take this opportunity to make favourable changes to their fund portfolios. The longer the maturity of a debt fund, the more vulnerable it is to changes in interest rates. One of the major advantages of debt funds is that there are various maturities to choose from.
Inflation can either help or hurt your debt fund investment depending on the interest rate environment. Therefore, keeping a check on inflation is important. Armed with this basic information, you can choose the debt fund to invest based on your investment horizon and financial goals. You can either look at debt funds for one year or for longer maturities.
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