A 25 basis points hike in the upcoming policy would be the last in the rate tightening cycle, given recent domestic and global developments, says Shriram Ramanathan, portfolio manager, Fixed Income at Fidelity Mutual Fund. In an interview with FE?s Chirag Madia, Ramanathan says that policy actions would depend on various fast data indicators that would be released over the coming months, such as PMI, IIP, and auto sales. Excerpts:

Last week 10 year yields went up 20 basis points on announcement of increased govt borrowings. Where do you look at bond yields in the days to come?

I think the announcement was definitely a negative surprise for the markets. Most bond traders did expect a budget deficit overshoot in the remaining part of the year. However, the surprise was despite increase in borrowings the fiscal deficit target was retained at an optimistic 4.6%, and hence subject to more upside risk. Lot of other factors such as domestic growth slowdown and inflation trajectory, as also global risks emanating from the European debt crisis would play a more important role in influencing our bond markets over the medium term. The upcoming RBI policy meeting on October 25 assumes added significance in providing medium term direction for the bond market.

Do you think in the forthcoming policy, RBI will hike interest rates again or take a pause?

RBI has already prepared the market for one more hike and I don’t think this will come as a shock to the system. With the government announcing an increase in the borrowing programme and risk of further slippage on the deficit front, it has become all the more critical for RBI to first tame inflation. Only then, would they have flexibility to support the market through open market operations, should the need arise towards the later part of the year.

Do you believe inflation has reached a peak?

Inflation is expected to remain elevated over the next few months, before showing a downward trend from December. Given that RBI has been quite hawkish and they have kept interest rates on an upward trajectory, one could argue that on their part they have done enough to ensure that the interest rates sensitive sectors respond to the high cost of borrowing , translating into weaker demand and hence lower inflation.

How many more rate hikes are you expecting in FY12?

The RBI?s policy actions have become extremely near-term data dependent, without the luxury of allowing for the typical time lag of 2-3 quarters for full monetary policy transmission. Hence, policy actions would depend on the various fast data indicators that would be released over the coming months, such as PMI, IIP, auto sales, bank credit trends, apart from the inflation readings. Despite the risks, I do feel that the 25 basis points hike in the upcoming policy would be the last in this tightening cycle, given various domestic and global developments recently.

Which are the best debt products to invest for retail investors?

We believe that investors should gradually increase their allocations to open-ended bond products (instead of locking all their money into close ended FMPs), given that we are approaching the end of the rate-hike cycle and there is good possibility to benefit from yields moving lower over the next year or so.

Within this segment, short term income funds, with good underlying credit quality, offer the best risk adjusted returns for investors with a 6 months to 1-year investment horizon by delivering attractive yields while still keeping risk low.