Ideally bond yields should move lower because of easy liquidity and rate reductions by RBI along with accommodative stance.
Investors should continue to remain invested in funds that are invested fully in sovereign bonds or AAA credit quality given the current period of economic hardship, says Sujoy Kumar Das, head, Fixed Income at Invesco Mutual Fund. In an interview with Chirag Madia he also said that going forward the Reserve Bank of India (RBI) would follow easy monetary policy. Edited Excerpts:
What is your outlook on debt market?
We have a positive view on the debt markets, particularly the asset quality which comprise of the top 80% of the market which are the sovereign segment and the AAA-rated and PSU bonds. We expect this segment to outperform the other segments of the market led by risk aversion amongst the investors and surplus liquidity within the banking system chasing high quality assets. Over the last 1-2 years, these segments have been outperforming the rest of the debt market.
It is important to first get things in perspective. The Indian economy is not doing too well because of the lockdown and spread of the virus. It has impacted the income and revenue of corporates, households, individuals and the tax collections of the government. The impact is being felt across the organised and the unorganised sector.
The Goods and Services Tax (GST) numbers for the month of April and May has been ~ 50% lower than the trend. This year seems to be posing an unprecedented challenge for both the private sector and the government. We also acknowledge the government and the Reserve Bank of India (RBI) announced multiple policy measures as a stimulus to revive the economic growth. The results are still awaited. Repayment of the existing debt is an immediate problem being faced by all. I think this problem was understood early on by the RBI governor and hence announced a 3-month moratorium on term loans and later extended by another three months.
In this scenario where government’s ability to push through fiscal stimulus is limited due to low tax collections, we feel RBI has to do bulk of the heavy lifting in terms of revival. Their actions so far (viz., LTRO, TLTRO, CRR, OMO), to infuse liquidity has been useful. At the same time, they are also cutting interest rates such that the cost of money becomes cheaper.
What kind of measures do you expect from the RBI going forward? How much rates cuts you expect in this financial year?
RBI is expected to pursue easy monetary policy. Keep reducing interest rates and infusing surplus liquidity. The objective of government and the RBI is aligned, both want the economy to come back on rail and the revival to happen. Interest rates need to be lowered such that it encourages depositors to look at other financial products and not just saving in bank deposits. That is to turn depositors into investors or consumers.
It’s difficult to assess how deep the rate reduction cycle will be, but we feel having started the process of rate reductions to revive growth (and this year there may be contraction), we expect RBI to maintain the accommodative stance on monetary policy and continue the rate reductions till the point the rates do not appear attractive to the bank depositors any more. The money needs to be either spent or invested and not saved. If people only save money, then the economic revival is challenging. It is difficult to put any quantum of rate cut in this financial year given the current situation. Right now, repo rate is at 4% and bank FD rate is between 3-5% (up to 2 years FD deposit rates). We are still witnessing a healthy growth of bank deposits, and hence we have not reached the desired deposit level yet.
What kind of investment strategy are you adopting at this point of time?
We are trying to remain safe, by investing only in top quality credits which includes, government of India bonds or blue-chip AAA credit and AAA PSU bonds to preserve the capital of the funds. Secondly, we are slightly long on durations (an indicator of price sensitivity to the changes in yield), relative to the benchmark. Duration management helps in using interest rate movement as part of active fund management. Like the present strategy of relatively longer duration helps in using interest rate decline to our advantage.
Where do you see Government Securities (G-Sec) yields settling given the high borrowing programme of government?
Ideally bond yields should move lower because of easy liquidity and rate reductions by RBI along with accommodative stance. With expectation of a gross domestic product (GDP) contraction, the cost and price levels ideally have to move southwards (including the cost of money and yields of bonds). However, since government has enhanced their planned borrowing calendar by more than 50%, the bond yields are under pressure and has not moved lower ever since. We feel that the demand supply dynamics has to be managed better by the RBI, by creating an equivalent and more demand for government securities so that g-sec yields don’t move higher (due to extra borrowing). Any rise in bond yields will create additional headwinds for any kind of economic revival led by monetary economics. It’s hard to predict where will G-sec yields will settle because it has yet to price in entire repo rate reduction so far. The erstwhile 10-year benchmark yield is still close to 6% whereas the repo rate is at 4% which means the g-secs have not priced the entire rate reduction. (the long period average spread of the 10-year g-sec over the repo rate is around 60-70bps compared to the present spread of ~200bps).
What are the key concerns as a debt fund manager?
First concern is related to the challenges in the credit market as there has been downgrades and defaults in the past few quarters. Trying our best to maneuver better and steer clear through this high credit risk phase. Second concern is the appropriate duration to be managed for the fund where the current challenge is to assess the ability of RBI to match up the extra borrowings of the government such that the g-sec yield and the bond yields do not move higher during this period.
Flows into debt funds have been very volatile in the past few months, do you think more pain is left in terms of sharp outflows from debt funds?
There have been some outflows in March and April, but money has started coming back in May and June. The assets under management (AUM) are pretty much at peak levels. RBI has continued to infuse liquidity in the system and there is more cash in the banking system. We do not expect the banks to keep the cash with them for long and flows into non-banks like debt funds will begin soon.
What kind of products should investors look at debt funds at this point of time?
Investors should remain invested in superior credit quality funds (funds which 100% invested in sovereign bonds or AAA credit quality or a mix of both). This credit segment is outperforming the rest of the market and is expected to behave in line with the past. More so during this period of economic hardship. Investors should also select funds with portfolio duration slightly longer than their investment horizon during this period of rate easing. This duration strategy will ensure that the interest rate decline is managed in favor of return on a risk-return matrix.