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Journalism of Courage
The Indian debt market has long been operating within the environmental framework of rising interest rates and high inflation. The present phase of price rise,too,can be partially explained by the demand-supply mismatch in food articles segment,and partially due to the global rally in the prices of core commodities,especially crude oil.
Having said that,inflation in the food prices is expected to moderate in two to three months. This may be attributable to a combination of factors,particularly the onset of the high base effect and the improvement in the food supply situation. However,it is the 44% spike in the international prices of crude oil in the last four months and the price spillover in the general economy worldwide that has emerged as a more critical concern for the central bank and capital markets participants alike. With no respite seen on that front,we can expect fuel-led inflation to continue to cast a long shadow on the inflation outlook for some more time.
Consequently,the Reserve Bank of India (RBI) is expected to maintain a predominantly hawkish stance with respect to the key interest rates. We expect RBI to hike rates in response to the inflation numbers in May 2011. That would take the repo rate to 7%. From there on,we may see one or two more rate hikes in 2011,since further incremental rate hikes would be data-driven. However,the policy stance by RBI may undergo a change if the factors affecting the crude oil prices mollify.
On the government borrowing front,though the fiscal deficit for financial year 2012 has been projected lower than that of financial year 2011,there is not much reduction in the overall quantum of borrowing. Week-on-week supply of government securities is tending to exert an upward pressure on interest rates. Added to that,crude prices continue to be remain sticky,posing a threat to inflation. In such a scenario,it would be advisable to wait for some more upward movement in the gilt yield curve to time an entry into duration strategies.
Similarly,the interplay of liquidity is another factor that has an impact on the performance of debt instruments and debt funds. The market currently is a net borrower of around R40,000-60,000 crore. This is still a respite from a more despairing liquidity situation earlier,when the liquidity deficit was in the vicinity of R80,000-1,00,000 crore. As a result,the money market curve has steepened gradually over the past few weeks.
Going forward,it is expected that with the RBIs intention to keep liquidity in the vicinity of plus/minus 1% of NDTL (net demand and time liabilities) to rectify the liquidity paucity,the curve may continue to follow the present trend. Further,overnight rates may hover at around 6.75-7% levels (barring event-led spikes during advance tax outflows,etc).
Consequently,the funds positioned at the shorter end of the curve (at around three to six months) may gain with the cascading repositioning of older debt. This is because,with the older maturities emerging as the fresh near-term paper,the resultant re-pricing of the said asset may provide higher carry on the overall portfolio. Investors with a short-term horizon of,say,under one year could consider portfolios with larger accrual components.
Furthermore,the one year and above fixed maturity plan (FMPs) segment is another product category that an investor may look at,given the high interest rate scenario we are in today. Since these products broadly buy assets maturing on or before the schemes maturity,there is very negligible interest rate risk for the investor.
To summarise,fixed income investments offer opportunities both in a rising as also in a declining interest rate environment. One needs to harness the full potential of such avenues at opportune times.
*The writer is head of fixed income and products,Kotak Mutual Fund
