The RBI surprised the market with a 50-bps rate cut in its last policy review. According to Amandeep Chopra, group president and head of fixed income, UTI Asset Management, inflation may decline going forward, which could give some room for the RBI to effect more rate cuts during the course of the year. In an interview with Ashley Coutinho, he expresses concern about further fiscal slippages. Chopra advises investors to look at FMPs, short-term income funds and bond funds at this point in time.
The government has upped its borrowing plan for this fiscal. How will it impact the bond market?
There was clearly a sense of discomfort in the market as the number surprised on the upside. The G-Sec market was quick to react as the yields of the 10-year benchmark paper shot up to 8.8%. Out of the estimated net borrowing of R4.9 lakh crore, close to R3.3 lakh crore can be absorbed domestically by insurance companies, banks and other financial institutions. The surplus of close to R1.6 lakh crore will be a big overhang on the market.
Our view is that the RBI will continue to come up with open-market operations (OMOs) to absorb some of that excess supply. There could also be some relaxation in terms of investment by FIIs into government securities. If these two things come to pass, the impact on the market should be minimal. However, the concern among market participants is that the government could overshoot its borrowing target if the fiscal deficit targets are not met. If that happens, it will be perceived as a big negative.
How does the market view the RBI?s move to cut repo rates by 50 bps?
There was near-consensus among market participants that the RBI would go for a 25 bps rate cut. There was not much optimism for significant policy action initially as there were a number of issues that RBI had been grappling with for most of the last year-and-a-half. The central bank?s policy review a day before it slashed interest rates also sounded hawkish.
In that backdrop, the market was clearly surprised with the quantum of the rate cut and reacted very positively to it. We saw the G-Sec rally significantly from about 8.47% to 8.3% on the same day and the three-month and one-year CD rates rally by almost 20 bps.
The question is what will happen next? As the curve steepens, the short-term rates should come down a bit more. The market, in general, was expecting a rate cut of about 75 bps for the entire financial year.
Now, that a rate cut of 50 bps has already taken place, the markets will have to try and adjust to the reality that there might only be a 25 bps cut going ahead. But what if the macro picture improves to an extent that the central bank can go for more rate cuts? That is what remains to be seen.
Which debt products do you expect to do well post the rate cut?
I believe the short-term income funds, such as the UTI Short Term Income Fund, which have an average maturity of 2-3 years, will do well as the yield curve becomes steeper. The yield curve is presently inverted; it will steepen and, then, move down over a period of time, a scenario in which bond funds and income funds can do well taking into consideration a period of 12-15 months. Since we are not going to see a steady decline in yields, any fund which can dynamically change its duration will gain. Dynamic bond funds can also do well as the market may be range-bound and driven more by trading between now and the next policy meet. So, funds that can actively trade the markets in a band in which the 10-year benchmark or the triple-A corporate bonds move will benefit. UTI Bond Fund follows such a strategy with an active duration calls.
How do you read the trajectory of interest rates in the year ahead?
We were looking at a rate cut of 100 bps for FY13. Of that, 50 bps has been front ended. Our view is that inflation will decline and may give some room for the RBI to effect more rate cuts. India?s GDP is growing below its trend line, and the lower growth should curb the excess demand-supply mismatch, which is the biggest worry for inflation. The GDP growth has slowed down to 6.1% sequentially. Even if inflation stays in the band of 6%-6.5%, the focus will shift to growth. Core inflation has been trending down to sub-5% and, if that trend prevails, the RBI will be in a much more comfortable position to cut rates.
What is your advice to investors?
I would suggest three things. Investors wanting a predictable return profile could look at fixed maturity plans as interest rates are likely to come down further going forward. Those with a 12-month investment horizon and who don?t mind the day-to-day volatility could invest in short-term income funds. Those with a slightly longer horizon could look at bond funds, which can trade actively and can benefit from decline in long-term rates as rate cuts and fall in inflationary expectations shift the yield curve downwards.