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A Small Prick

Tata Power Company's debentures have been downgraded from AAA to +AA. Not alarming, as bond funds don't own it in a significant proportion. The real point is that downgrade raises credit quality issues of bond funds.

Credit rating agency Crisil has downgraded Tata Power's Rs 1,000 crore non-convertible debenture (NCD) issue, from AAA to +AA. The reason: the company has increased its exposure to the group's telecom venture (Tata Teleservices), which Crisil believes will earn returns over the long-term and could lead to a considerable increase in its debt position.

In the past one and a half years, bond funds have had a great ride, with interest rates on a downward journey, aiding funds in actively managing interest rate risks. But then bond fund returns are also affected by credit risk as well. Hence, a downgrade or an upgrade of credit quality of an issue can have a bearing on the fund's performance.

Now, with the economy looking up, the focus has shifted from government securities to corporate bonds. And the fund managers have been pegging hopes on the fact that the economy taking off will improve the credit quality of below-AAA bonds. Contrary to this belief, in the past one year, we have witnessed two rating downgrades and one major upgrade – merger of Reliance Petro (+AA) with Reliance Industries (AAA). The downgrade of Tata Power NCDs is the second major downgrade since July 2001, when IDBI was downgraded from AAA to +AA. Though at that time most bond funds had significant exposure in IDBI. As for Tata Power NCD, it doesn't hold significant position in any of the bond funds except some funds

Tata Power: Not So Electrifying
  Fund Name  % of Net Assets*  Size in (Rs Cr)*  
  HDFC Children's Gift Saving 4.52 24.25 
  Sundaram Bond Saver 4.26 584.22 
  Reliance Income 3.38 485.78 
  HDFC Income 0.48 2611.14 
  Pru ICICI MIP 0.40 421.57 
  Pru ICICI Income Plan 0.23 3023.72 
* as on July 31, 2002

    What Does Downgrade Mean
The impact will be a trickle, that too a short-term impact on the NAV of bond funds. However, the downgrade issue once again rakes up credit risk issues for these funds, particularly with government yields having almost bottomed out, funds will have to depend on corporate bonds to boost returns.