The RBI after the last policy, has clearly demonstrated that it would not compromise on price stability focus, as it does not prefer to sacrifice inflation for higher economic growth, says Dhawal Dalal, CIO-fixed income, Edelweiss AMC.
The Reserve Bank of India (RBI) after the last policy, has clearly demonstrated that it would not compromise on price stability focus (inflation target at the expense of growth), as it does not prefer to sacrifice inflation for higher economic growth, says Dhawal Dalal, CIO-fixed income, Edelweiss Asset Management Company (AMC). In an exclusive interview with Chirag Madia, he adds that, from the retail markets perspective, categories like equity opportunities funds, monthly income plans (MIPs) and balanced funds may offer exciting investment avenues. Excerpts…
After the recent policy, what’s your outlook on debt markets?
The Reserve Bank of India (RBI) has surprised the bond market, but with the change in stance from Accommodative to Neutral, we believe the RBI has sent two clear messages. One is, by becoming neutral, market participants have scaled down expectations of any further rate cut in the near-term. The RBI has clearly demonstrated that they would not compromise on price stability focus (inflation target at the expense of growth), as they do not prefer to sacrifice inflation for higher economic growth. Secondly, it seems for central bank containing inflation is paramount and so in the hindsight market participants will appreciate this stance. Our current assessment of the macro-economic parameters suggest that bond yields are likely to remain range-bound with an upward bias as we expect headline consumer inflation to trend higher and emerging markets (EMs) in the near-term. Our understating is that, inflation may surprise on higher side amid recent surge in food, energy and industrial commodities prices. This will result in central bank maintaining its stance hawkish.
Where are bond yields likely to settle going forward?
Judging from the recent developments in the global macro-economic landscape, we believe that 2017 may be a tough year for bonds; We suggest investors to moderate their expectations from the bond market and be content with coupon accruals. Last year, benchmark bonds in India generated returns in the range of 10-15% depending on the duration. This year investors should reconcile to the fact that benchmark bonds may deliver only coupon income. It is important that investors understand this development and do not have anchoring bias based on last year’s performance. My sense is that 10 year government bond yield may end at somewhere in the range of 7.25% by December this year, if SDLs remain where they are currently.
In such situation where do you see interest rates moving going forward?
From the policy rates perspective, the RBI will prefer to hold on to rates for some time, unless crude prices breach $65 per barrel and our trade deficit, which is less than one percent of the gross domestic product (GDP), starts widening. If headline inflation trends higher from the RBI’s 4% target, then there are chances of a rate hike. However, at this point of time, we expect RBI to keep rates on hold amid hawkish FOMC stance. Having said that, it is important to note that aggregate cost of borrowing for market participants have been trending down. Most of the market participants are borrowing cheap through commercial paper route and now MCLR has reduced by 70 to 90 basis points. We expect the recent reduction in MCLR rates to help reduce borrowing costs. Therefore, I think there would be status quo until August this year.
What according to you are key risks in such market scenario?
Right now, the risk in the markets as far as mutual funds are concerned is for sudden outflows from debt funds. Secondly, market participants have factored in two rate hikes from the Federal Reserve this year. However, if they sound hawkish and surprise with a third rate hike, then market participants will re-price the risk of hawkish Fed. This may prompt a gradual upward move in the US yield curve and may impact the term-structure of global bond markets.
Given the current situation what strategy should investor adopt at this point of time?
We advise retail investors to consider shorter-end for safety in debt products. It is important for them to recognize and realize that duration play is over from the current perspective. On the other side, equities may have potential to generate better returns if earnings cycle improve. From the retail markets perspective, categories like equity opportunities funds, monthly income plans (MIPs) and balanced funds may offer exciting investment avenues.