With insurance companies, banks and pension funds not participating in the bond market aggressively, there is a growing gap between supply and demand in the bond market. Devang Shah, head ( fixed income) Axis Mutual Fund, which has Rs 1.25 lakh crore in debt schemes, tells Christina Titus this could be addressed, if the government reduces the supply of long duration bonds by 3-5%. Excerpts:
Is the market anticipating that GST rationalisation will lead to increased borrowing from the government?
For the overall economy, GST rationalisation is very positive. From a bond market perspective, the impact on monetary policy is largely neutral, as fall in CPI will largely be negated by positive impact on GDP. Also, if the fiscal tool is utilised, monetary policy can take a backseat. However, a bigger concern is about the demand-supply dynamics for bonds when the government resorts to fiscal measures. Further, when the pay commission recommendations are implemented next year, there could be significantly larger payouts. This raises questions about how the government will manage fiscal discipline moving forward.
While borrowing numbers may not change significantly this year due to available fiscal levers, gross borrowing could increase by around Rs 1–1.5 lakh crore annually over the medium term. This is concerning given the currently weak demand in the bond market, mainly driven by reduced incremental buying from pension funds, insurance companies, and banks, largely due to regulatory changes. This has led to widening gaps in supply and demand, where government borrowing supply remains constant or may even increase next year, but demand is not keeping pace. One possible way to alleviate this pressure would be for the government to reduce the supply of longer-duration bonds by 3–5%.
How do you see bond yields play out in the near-term?
We expect the benchmark bond yield to trade in a range of 6.30-6.50% in the near term. However, if there is significant fiscal expansion, the yield could move towards 6.75%. As mentioned earlier, the demand-supply dynamics are currently not working in favor of the bond market, which is why we have seen a rise in yields for government bonds, especially in long bonds. With the GST cuts, the RBI is likely to project inflation for next financial year 50-70 bps lower, providing room for a 25 bps rate cut.
How have you positioned yourself in this scenario?
We have been shifting to the short end of the curve since May. I believe that the incremental rally in long bonds is limited and risk-reward for short bonds is in favor as the banking liquidity is strong. We have also moved our portfolio to have a higher allocation to corporate bonds.
Which funds should investors be betting on?
For medium-term debt allocations, income plus arbitrage funds of funds represent an optimal solution. At Axis Mutual Fund, we intend to manage the fund dynamically, acting like longer-duration bonds in a rate-cutting cycle and like low-duration bonds when rates are rising. For investors seeking shorter-term parking, money market funds can be a suitable option. Overall, for those with a two-year or medium-term investment horizon, income plus arbitrage funds can be the preferred choice due to their flexibility and tax efficiency.
Debt schemes received huge inflows in July. Do you think it will sustain?
A large portion of the expected inflows has already materialised. The remaining 20-25% could come in over the next few months, but flows into debt schemes with durations greater than one year are likely to be muted going forward, reflecting cautious investor sentiment amid the current interest rate environment. We believe that flows in new category income plus arbitrage funds of funds would continue and this category would become good tax optimal solution for Investors
S&P upgraded India’s rating to ‘BBB’ from ‘BBB-’. How do you assess the benefits of this development?
The upgrade is marginally positive for the bond market as it boosts investor sentiment. However, it is not expected to drive significant inflows into the government bond market directly. For corporate borrowers who significantly raise funds offshore, the upgrade will reduce borrowing costs by approximately 20-25 bps, providing some relief. Still, the overall impact is expected to be incremental rather than transformational.
The first quarter has seen record issuances in corporate bond market due to fall in rates. When the yields are rising or stable, do you think the banks will move to bank credit?
Once the last 40-50 basis points of transmission of rate cuts occur, we anticipate that corporates will begin to tilt back towards bank borrowing. Previously, with corporate bond yields falling substantially, and banks’ base rates having not been cut correspondingly, there was a spread of 70-80 basis points favoring corporate bonds. We expect that around 10-15% of corporate borrowing will gradually shift back to bank credit, especially as bank rates adjust and credit growth improves.