The RBI is not likely to hike key policy rates in the year ahead as its measures to tighten liquidity are non-permanent in nature, believes Sanjay Shah, head, fixed income, HSBC Global Asset Management. In an interview with Ashley Coutinho, he says inflation levels are likely to remain sticky in the year ahead.

Yields have shot up substantially since July 15. Do you see them stabilising in the near term?

Yields have moved up by 75-100 bps in the long end of the yield curve (6-30 years) and by about 200 bps in the less-than-five-year segment. This is largely due to the liquidity tightening measures and increase in overnight rates by the RBI. Bond market yields have stabilized at about 8.20-8.40 for 10 year g-secs, based on the fact that the RBI has opened a window for open market operation purchase to support the long-end of the yield curve. The fate of yields is tied to some extent to the currency as monetary policy is used as a defence in the currency space. Thus, yield stabilization will also depend to some extent on the currency stability.

RBI has announced an R8,000-crore bond buyback programme to ease liquidity. What impact will the move have?

The RBI?s decision was primarily announced to check long term g-sec yields, which had significantly surged by around 200 bps post the announcement of tightening measures. It is not likely to impact the system liquidity notably. However, further announcement of OMO purchases and tweaking in CMB (cash management bills) issuances may impact liquidity positively. We had suggested that the August announcement would positively impact long-end funds, which has turned out to be true. It must be noted that the recently issued cash management bills are designed to mature in mid-September in order to negate the seasonal tightness in liquidity arising out of tax outgoes.

How do you read the trajectory of interest rates in the year ahead? Any likelihood of a hike in key policy rates?

We do not think the RBI will hike policy rates as the liquidity and overnight rates measures are clearly targeted towards stabilising the currency market and are non-permanent in nature. In fact, growth may slow down further due to the higher short-term rates and increase in the banks? base rates. So, once the currency market stabilizes, it may be necessary to look at lowering the overnight rates.

Will the currency depreciation fuel inflationary pressures once again?

Currency depreciation is likely to cause the inflation to increase to some extent. The rise in global crude oil prices is also likely to affect inflation. Having said that, inflation may be contained in food items due to a better monsoon. Yet, overall, inflation levels are expected to remain sticky at about 5-6% for the rest of the financial year.

Which debt categories are expected to do well in the

coming months?

In the next few months, short term income and ultra short term bond fund categories may provide good value for the risk taken or for the given volatility. Bond funds may see higher volatility due to liquidity and other measures taken by the RBI. However, we do feel that over a one year horizon, long-term bond funds and dynamic funds are likely to outperform the short-end funds.

Most debt categories gave 9%-plus returns in FY13.

Should investors temper their returns expectations from debt funds this year?

Investors could keep a reasonable return expectation from debt funds, given the fact that the central bank?s liquidity measures are non-permanent in nature and the lower growth may prompt rate easing once the currency market stabilizes.