‘The market has already priced in one more hike by RBI’

ICICI Prudential Life Insurance Co ensures that at least 75% of its corporate debt papers are ‘AAA’ rated. Jitendra Arora, senior vice-president (fixed income investments) of the company tells DNA that some of the parameters that they look at are company cash flows, outlook, management quality, potential stress factors and sector outlook. According to Arora, the company will not like to chase the highest possible yield and is willing to sacrifice some yield for better quality and stability of performance Excerpts from the interview:

What is your current assets under management (debt)? What is your view on investments in light of the monetary policy review to be held this month?
As of May 31, 2011 we had about Rs25,000 crore of debt funds under management. As an insurance company, we focus at managing investments with a long-term perspective, given the available opportunities. An event like a monetary policy review may be very critical to a short-term investor who is trying to time the market but not so much for a long-term investor like us.

Various studies show that asset allocation, not market timing, is of paramount importance to investors. This is precisely what we try to focus on while selling our products. With attractive equity valuations and high bond yields, we believe we are at an interesting juncture as both equity and debt offer attractive investment opportunities in the Indian market from a 5-10 year horizon.

What are your expectations from the Reserve Bank of India (RBI) policy review on June 16? Do you think the market can absorb one more rate hike this month (if that happens) so fast?
To hike the interest rate or not is an extremely close call at the upcoming RBI policy review. Factors like incomplete pass-through of globally high oil prices, elevated commodity and food prices and a chance of improving global economy are likely to weigh in favour of a hike. However, there are early signs of moderation in growth like slower auto sales, slightly lower purchasing managers index (PMI) for May and lower investment growth. Consumption demand though remains reasonably strong, thereby creating a dilemma in the minds of policymakers.

However, we believe that RBI may want to further tone down high inflationary expectations and thus hike the rates by 25 basis points. The market has already priced in one more hike by RBI.

A few insurance companies told us that currently most of them prefer a gilts portfolio which comprises short-term gilts. Is this the case even with your company? What is the average duration?
We have traditional as well as unit-linked funds. The amount and duration of gilts in these portfolios is driven by various considerations like investment regulations, asset-liability management (ALM), reasonable expectations of policyholders, benchmark and our outlook on interest rates.

For instance, traditional endowment funds will continue to invest at least 40-50% in long-term gilts irrespective of the rate view as it is necessitated by ALM considerations and investment regulations for the fund. Thus, different policyholders’ funds will have different allocation to gilts and durations at any given point in time. It may not be appropriate to look at the overall duration of the gilt portfolio.

Despite lower government borrowing in fiscal 2012 there have been devolvements in gilt auctions. According to you what are the reasons for the same?
The government has projected a lower net borrowing for fiscal 2012 as compared to fiscal 2011. The same is on the back of expectations of robust growth in revenues and moderate growth in expenditures. However, expectation of higher oil and fertiliser subsidies, lower growth in taxes and failure in raising disinvestment proceeds, given the weak capital markets may upset government deficit plans and lead to higher borrowings in the year. This coupled with RBI’s aggressive tightening and inflation fears kept market participants away from subscribing to gilts in auctions leading to devolvement.

What is your outlook on May 2011 inflation data? What all factors are driving it? Do you think inflation will moderate to 6% (RBI’s target) by 2012?
We expect May inflation data to marginally decline to around 8.50% as compared to the last reading of 8.66%. There is a reasonable chance of inflation moderating to around 6.5% levels by March 2012. High rates have started acting through the system and are moderating growth. High savings rates tilt the balance between savings and consumption for individuals. As demand weakens slightly from current levels, the pricing power for corporates would come down and lead to a moderation in overall prices. The big risk though is a rise in input prices like commodities or failure of monsoon affecting expected moderation/stability in food prices.

The gross domestic product (GDP) numbers have started slowing down. What is your outlook on the GDP numbers for the first quarter of fiscal 2012 as well as for full fiscal?
We expect fiscal 2012 GDP to be in the range of 7.5%-8% for the first quarter as well as full year.

What are the parameters you keep in mind which buying corporate debt papers? Which are the preferred sectors?
As a life insurance company, we primarily manage retail money and hence have prudent regulations for corporate debt papers. As per regulations, we need to ensure that at least 75% of our corporate debt papers are ‘AAA’ rated. Thus quality of credit is of paramount importance to us. Some of the parameters that we look at are company cash flows, company outlook, sector outlook, management quality, potential stress factors, etc. We do not like to chase the highest possible yield and are willing to sacrifice some yield for better quality and stability of performance.

In your funds you have exposure to fixed deposits with banks. What is your outlook on bank fixed deposit rates?
We believe that bank fixed deposit rates are close to their peak. We expect deposit rates to rise marginally and plateau thereafter as rates have risen by more than 300 basis points over the last one year. This is primarily based on our view that the current high rates would lead to better deposit accretion through the year. Credit may slow down in the second half of the year precluding a need for funds by banks and hence easing pressure to raise deposit rates further.

Are there any negative surprises in store for the debt market (besides inflation) in fiscal 2012?
There can be two sources of negative surprises for the debt market in fiscal 2012. One, the fiscal deficit target may be challenged for reasons that have been mentioned earlier, potentially leading to higher borrowing and a spike in yields. Two, given the importance of monsoon to the Indian economy, any negative surprise there would be negative for both the markets.