Most of the current fears surrounding fiscal concerns have been priced in the current bond yields says Kumaresh Ramakrishnan, head ? fixed income, Deutsche Asset Management. In an interview with FE?s Chirag Madia and Devangi Gandhi, he says he expects movement in G-Sec yields to depend largely on the extent to which fiscal deficit stays in line with the budgetted number.
Inflation remains at elevated levels. Where do you see interest rates of the economy?
Our view is that barring any unforeseen extraneous events, the rate-hike cycle seems to have reached the end of its course. In fact, the central bank has in the latest quarterly policy guided that the probability of a further rate hike in the December policy is relatively low.
We believe that going into December and January, inflation will start softening due to combination of factors such as base effect and Kharif crop harvest. Besides, RBI has also indicated that the full impact of the past few rate hikes could take a couple of months to play out which would help in cooling off demand.
Even as we seem to have reached the end of the rate hike cycle, we do not see rates coming off quickly from present levels. Inflation which is forecast to follow a downward trajectory to around 7% by March 2012 would still be over RBI?s indicated comfort zone. Until inflation dips below 6%, the historical long term average, probability of a rate cut appears low.
Where do you see the 10- year benchmark yields? Where do you think they will settle by the end of the current financial year?
We believe that most of the current fears surrounding fiscal concerns and issuances have been priced in the current yields. The benchmark 10-year G-sec bond is trading close to the psychological 9% level. Current auction cut-offs are reflecting fears of a further breach in the recently revised borrowing limit by R52,800 crore.
In the past, RBI has resorted to OMOs (Open Market Operations) to cool off G-Sec yields. Given the high prevailing inflation, RBI has possibly refrained from conducting an OMO. However as inflation starts trending lower, RBI retains the OMO option.
Going forward, movement in G-Sec yields will depend largely on the fiscal position. If the fiscal deficit stays close to the budgetted levels and there is no additional borrowing by the government in the second half, then yields could possibly trend lower. On the contrary any pressure on tax mop-up in Q3/Q4 ? FY 2012, could lead to fiscal concerns for the rest of FY 12 and FY 13, exerting some pressure on yields.
Where do you think investors should put their money at this point of time?
Keeping in mind risk appetite and investment tenure, investors could consider both the short end (liquid, ultra short term) and the mid-segment (short duration and medium-term) of the yield curve. Given the likelihood of no further changes in policy rates, the short and medium-segment looks even more attractive. Risk-reward is turning highly favourable for this segment, as we expect lower yield volatility going forward, since the macro should start improving based on past rate actions.
In addition to the high coupons, investors in this segment stand to benefit from potential capital gains as and when rate softening sets.
Central banks are de-regulating the savings account. Do you think it will hit the inflows into liquid schemes?
The move is expected to have only a marginal impact on flows into this category, since in value terms the quantum of flows into liquid funds is relatively modest from retail investors. Institutional investors should continue to remain invested in liquid funds as returns in this category continue to remain superior to other alternatives. Also, investment in MFs is more tax efficient.
If the interest rates are likely peak-out, don?t you think investors should put money into the fixed maturity plans (FMPs)?
In the regime of rising interest rates witnessed over the last 12-15 months, investors have preferred close-ended funds such as FMPs to open- ended duration products. As we enter a stable rate environment, albeit at higher levels, investors could start actively considering open-ended short and medium-term duration products for their asset allocation since this offers the prospect of potential capital appreciation in addition to coupon income.
What kind of returns are expected on the corporate papers and is there enough supply in the market?
On the corporate side, the interesting development is that as banks have successively raised base rates in the last few quarters tracking policy moves, there is a rate arbitrage emerging in the capital markets. This has led to more of the higher-rated corporates approaching the capital markets. So now in addition to the traditional borrowers, we are witnessing supply from manufacturing corporates from diversified sectors which is a positive.