Mr R Sivakumar
Head- Fixed Income – Axis MF.
Q. Inflation remained subdued since quite some in India. What reasons do you attribute to this comforting change?
Answer: Falling food price inflation has been the story of the year. The June inflation reading indicates food price deflation and the headline Consumer Price Index inflation dropped to a new low of 1.5%. What is more note-worthy is that non-food, non-fuel (a measure of core inflation) has also dropped consistently over the past three months to 4%. The persistent undershoot of headline inflation and a moderation of core inflation to RBI’s target of 4% has given the central bank room to cut rates.
To be sure, some of this fall in food prices could reverse in the coming months. In particular prices of pulses and vegetables have fallen by over 15% compared to last year. It is unlikely that this pace of fall can be sustained. It is much more likely that inflation would revert closer to the 4% level – that is, closer to the core reading. Even achieving a 4% inflation rate by the end of the current year would be a big win for RBI.
Q. Indian Rupee has been holding on to its turf against the Dollar in recent times and has even appreciated. What according to you are the reasons for this and how is it impacting the debt markets?
Answer: A stable current account, strong foreign investments and weak crude prices have helped the INR making it among the best performing currencies in emerging markets. India’s CAD at 0.7% of GDP in FY17 is the lowest this decade. The net FDI was higher than CAD for the third straight year. While India saw relatively lukewarm FII equity flows during 2015 and 2016. CY17YTD equity flows have been good at close to US$8.9bn. Additionally, US$17.5bn net FII inflows in debt have been a plus. Consequently, forex reserves are at an all-time high of US$393bn. Thus low oil prices, along with steady CAD/BoP, have driven the currency to hold up well. Further, strong developed world growth has lead to strong emerging market growth. This in turn leads to better currency performance.
India is enjoying a period of currency stability (and strength), low inflation and strong external sector. We expect there to be limited upside risk to yields because of the Fed’s actions.
Firstly, we should ignore the popular narrative that Fed rate hikes are bad for us. The Fed raises rates because the US economy is doing well. That is good for global growth and our exports; and in turn keeps the currency stable/strong. Indeed to that extent we should welcome rate hikes.
Second, the external sector is now a point of strength for India. Compared to the taper tantrum period four years ago (2013), various measures of external stability are better today: lower current account deficit, higher foreign reserves, lower India risks and stable funding costs. Of course, these positives have come thanks to stronger growth at home and weaker oil prices abroad. Thus, we must be awake to the possibility that some risks may yet strike if growth were to turn down or the current account worsens materially from here.
Q. Please enlighten our readers with the important factors that you consider are crucial while making investments in debt instruments. What are the headline macro-economic indicators you think are critical at this point in time?
Answer: Ex-tax considerations, investment horizon and risk appetite need to be kept in mind while investing in debt funds. That is to say that a short-term horizon and a higher risk appetite would mean that duration funds can be invested in with a positive interest rate outlook. On the other hand a longer term horizon and lower risk appetite would mean that short and medium term income/credit opportunity funds are preferred. Further, the overall macro view needs to be kept in mind. Currently, the overall macro situation is also supported by easy liquidity and an accommodative fiscal stance. The pace of remonetization has slowed in recent months and excess liquidity appears to be persistent. This has been supported by strong FPI flows. On the fiscal front, we have seen the central government hit 80% of its budgeted deficit target in the first quarter itself. Several states have announced farm loan waivers which could result in fiscal expansion. All these factors augur well for short term funds.
Q. Many investors do not realise the importance and contribution of debt markets for the economy. Please highlight this aspect and also comment on the importance of retail participation in the same via mutual funds.
Answer: Debt funds can be a powerful tool for income generation and wealth creation in some cases (in the duration space.) Liquid/ultra-short funds are useful for parking short-term surplus funds, short/medium term funds can provide steady returns and earnings from spread compression. Finally, duration funds such as long term help positively capture interest rate movements in the economy. Essentially, funds investing in longer duration bonds perform well in a falling interest rate scenario. Dynamic bond funds can position themselves across the maturity curve making them suitable in any interest rate environment although they are subject to interest rate movements.
Q. A lot of investors are revisiting their asset allocations. But when it comes to debt exposure, most are clueless as to which funds should they be investing in? What would you suggest to investors with medium to long term horizons, looking for decent returns from debt funds?
Answer: In the current market environment, investors should consider short-term corporate bond funds, which are relatively insulated from duration risks but take advantage of the steep short term yield curve.
Q. What investment strategy have you adopted to play these markets? What is your opinion on medium to long term interest rate movements which may be driving this strategy?
Answer: From a structural perspective it does appear that we are very close to the end of the rate cycle. At the same time easy liquidity has depressed money market yields.
On the credit front, several indicators suggest that the corporate profitability is on a recovery. Firstly, RBI study on corporates shows that the profitability of the corporate sector has improved over the past two years. This has been on account of both better operating performance and a reduction in leverage. Ratings data confirms the improvement in credit quality in the last two years. However, heavily indebted / highly leveraged companies appear to be still in a downgrade cycle. The fact that many more companies are being upgraded suggests a widening in the investible corporate space. Finally, the market pricing of credits has improved. Compared to the previous cycle, yield spreads are wider.
As investors, this presents an investment opportunity where the macro and rating developments are improving while yield spreads are relatively wide. Thus we have been increasing our allocation to below-AAA bonds. The ratings and micro level analysis still urges caution. The investment process needs to be strong with well-developed risk management.
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