Rate volatility to continue on CAD, fiscal deficit worries

Written by Ashley Coutinho | Ashley Coutinho | Updated: Jan 24 2013, 07:05am hrs
RBI in all likelihood will cut key interest rates by 25 basis points in the upcoming policy review, feels Dwijendra Srivastava, head of fixed income at Sundaram Asset Management. In an interview with Ashley Coutinho, he says volatility on the interest rate front is likely to continue as India tries to address both its current account and and fiscal deficits.

What is the quantum of rate cuts that you expect from RBI in policy review

We expect RBI to cut interest rates by 25 basis points. It is not that the inflationary expectations are behind us, but the logic of cutting rates stems from two facts. First, GDP growth has been clocking below the trend growth in last three quarters despite a relatively hawkish stance from RBI. Second, the recent measures by the government look concrete and will address the fiscal profligacy to a certain extent.

Rural incomes are rising causing higher inflation due to demand for quality food items such as milk, fish and egg. The supply-side bottleneck can only be addressed in medium term by better policies from the government and better state-centre coordination. On other hand, urban savings are declining as inflation is eating into the savings and incomes are rising at a slower pace. This, coupled with a higher current account gap, gives limited maneuverability to the central bank.

Bond yields are hovering near 7.87% mark. How do you see the yields moving in the coming week

We believe the benchmark 10-year bond yields will hover in a band of 7.75% to 7.95% in the coming week as the market participants have already discounted a 25 basis points repo rate cut and any rate action more than 25 basis points on repo rate can trigger further downside to the yields. On other hand, any hawkish statements or no action on the interest rate front can trigger an upmove on the yields.

How do you read the trajectory of interest rates in the year ahead

We expect interest rates to remain volatile as the supply-demand situation can check the yields at lower levels. The probability of inflation being in a lower band of 6% to 7% is high as the base will be benign. Any supply shocks on international commodity prices can push the inflation to a higher trajectory and with it the inflationary expectations. In nutshell, we can expect the volatility on the rates to continue as India tries to address the twin deficits current account and fiscal deficit. However, we expect interest rates to be lower from the current levels.

How has the past year been for debt funds

The past year has been good for fixed income funds with the duration funds, including short term income, medium-term income, long-term income, gilt funds and dynamic bond funds, outperforming the accrual funds (liquid and liquid-plus) on an average by 100 basis points to 150 basis points. On an average, liquid funds have delivered in excess of 9% as the yields from March 2012 on the money market buckets have declined by over 200 basis points. On duration funds, the yield decline has been to the tune of 50 to 60 basis points resulting in an average annualized yield of around 10% to 10.50%.

What is your advice to investors at this point in time

We believe that investors should invest as per their risk appetite. Next six to 12 months can pay off on the duration play. In the Indian context, the investor should be careful about the intermittent volatility as transient factors like supply side issues, pickup in global economic growth can bring in losses in higher duration products. We recommend investors to engage with their advisors and take a balanced view as per their risk appetite and invest accordingly.