Rate reduction cycle presents an attractive investment opportunity in the fixed income space
Foreign Institutional Investors (FIIs) have been sticking to the Indian stock market with record inflows this year. The net inflow from them has been more than $23 billion in calendar year 2012. We should also note that this is after a net outflow in the year 2011. This makes it the second highest net inflow in any calendar year. The highest being 2010, when they pumped in around $29 billion in Indian equities. This makes the cumulative investments in Indiaís equity market around $125 billion which is at an all time high.
But, the domestic investors seemed to be more interested in less risky investment options like debt. In other words, domestic investors may have been underweight in their equity allocations and may have increased their allocation in the fixed income assets in 2012. But 2013 could be a different story. With expectations of rate cuts, the renewed thrust in policy reforms and the likely uptick in industrial activity; the domestic investors are more likely to increase their allocation towards equity assets.
However, this may not curb the appetite for fixed income investors significantly. The gradual easing cycle has actually spelt good news for fixed income investors. The 10 year G-Sec has seen its yield falling from 8.4% in Jan 2012 to around 8.11% in Dec 2012.
As far as the key interest rates are concerned they have remained largely stable throughout 2012, though the outlook turned benign by the year close. RBI cut the repo rate by 50 bps in April 2012 policy changing the tone and direction of monetary policy to growth orientation. Thereafter, although there has been no repo rate cut due to inflationary pressures, the central bankís statements, a series of CRR cuts along with an SLR cut and the continued sombre growth data were all hinting at a more dovish rate regime ahead.
Indian economic performance over the years has been influenced by three broad systemic trends. That is the landed cost of crude oil, the aggregate agricultural output and the annual fiscal deficit. The interplay of these three factors determines the nature of inflation and the interest rates in the economy. This in turn impacts the aggregate demand and the aggregate supply status of the economy. Quite naturally, the debt and the equities markets remain a function of