I think this is the right time for gilt and income funds to perform. Given the falling rates, a long-term strategy will show positive results. We recommend fixed income investors to put money in long-term income funds for at least three years
The next trigger for rate cut will be the Union Budget that may give RBI a clear direction on inflation, believes Dhawal Dalal, executive vice-president and head-fixed income at DSP BlackRock Investment Managers. In an interview with Chirag Madia, Dalal said this is the right time for gilt funds, followed by income funds, to perform. Excerpts:
Was the RBI’s recent rate cut on expected lines? What is your outlook on debt markets?
The rate cut came as a pleasant surprise. Apart from softer-than-expected December CPI and WPI numbers due to lower food and oil prices, what may have prompted the RBI could be a sharp fall in near-term and long-term inflation expectations in its latest household inflation expectation survey. According to RBI, household inflation expectations have eased to a single digit in the December quarter, for the first time since September 2009. This is a marked improvement from the RBI’s September quarter household inflation survey where around 73% & 79% respondents had expected double-digit inflation three months and one year ahead. Given the overall market condition, we are positive. With the recent rate cut, we believe interest rates are on their way down. We expect at least another 50 bps rate cut by March 2016 and further rate cut would depend on factors like monsoon, crude prices, food prices and the US dollar. So if crude remains soft, along with good monsoon, and if inflation remains 5% below average, we may have further room for rate cuts.
Where do you think the benchmark bond yield will settle?
The 10-year benchmark yield, which is close to 7.7%, might touch 7% if repo rates go down to 7%. I don’t think 10-year benchmark yield should go down significantly below 7% in coming months. RBI had said it wants real interest rates closer to 1.5-2.5%. Based on expectations of an implied real rate of 1.5% to 2.5% and average CPI of around 5.5% in 2015, the benchmark 10-year government bond yields may find a floor at around 7% in the medium term.
What are your expectations from the next policy?
We expect RBI to maintain the status quo. After the recent rate cut, I don’t think RBI will slash rates immediately. I think the next trigger will the Union Budget, as it will give a clear direction on inflation. I think RBI will be also be looking at Crude prices. We expect RBI to start the borrowing cycle with a rate cut. My understanding is that RBI will wait for the Budget to decide its course of action.
Where do you see interest rates going in the next few months?
It will only decline from here, unless there is some dramatic change in the global market outlook. Currently, we are seeing deflationary headwinds everywhere. The only economy that has remained resilient is the US. There are three countries where interest rates have turned negative — Japan, Switzerland and Germany. We could see more countries getting in that territory if deflationary pressure gathers strength. Based on all the factors I think rates are on their way down. If the fiscal deficit is higher than the RBI’s expectation (RBI expects it to be 3.6%), it will be worrying and might impact the interest rate cycle.
What according to you are key risks in 2015?
At this point, markets are not envisioning any risks. But that doesn’t mean there are no risks which might have negative impact on the markets. The single biggest risk is the strengthening of the US dollar, and further strengthening could cause it to exert a downward pressure on emerging market (EM) currencies. In case EM currencies start losing value, there might be some exodus from foreign institutional investors (FIIs). The second risk that can have impact is inflation. As far as Asia is concerned, India South Korea and Malaysia are looking at a downward rate regime while other countries are looking at a rate hike on back of depreciating currency and prospects of inflation. We need to keep a close watch on any global problems.
What should investors do at this point of time?
I think this is the right time for gilt funds, followed by income funds, to perform. Given the falling rates, a long-duration strategy is likely to show positive results. We recommend fixed income investors put money in long-duration income funds with an investment horizon of at least three years. Investors with less than three-year investment horizon could consider investing in short-term funds and dynamic bond funds.
By Chirag Madia