Borrowing will be a daunting task for govt: Sundaram Mutual Fund

Dwijendra Srivastava, head of fixed income, Sundaram Mutual Fund, expects interest rates to remain volatile with a downward bias and believes the rate transmission in the general economy will lag the rate reduction cycle as the system struggles to fight a liquidity deficit. Srivastava talks about the related challenges and expectations in this interview with Neelasri Barman.

How would you rate the current debt market on a scale of 0-10? According to you, what are the challenges for debt fund managers in the current fiscal?
Given the current scenario of GDP, inflation, interest rates and oil prices, I would rate the debt market at 6 out of 10.

We believe there are always opportunities to make money in all kinds of markets although challenges are many like a higher net borrowing of the government, tighter liquidity conditions and a large current account deficit keeping the rates volatile. The challenge for fund managers is to be nimbler than before. Specifically, in the mutual fund space, the changing landscape of fund management will have its own challenges.

What is your outlook on FII investments in the debt market in FY13?
On the debt side, the differential in interest rates will make India attractive. The caveat lies in the recent changes in FII allocation of the limits, and making it difficult for FIIs to trade on debt holdings can result in the potential not being realised. On the taxation side, until there is clarity on GAAR (General Anti Avoidance Rule), FIIs will keep fresh inflows on hold. Further, any deterioration on macro factors like inflation or external situation can be a challenge to fresh inflows.

The RBI will announce the monetary policy statement later this month. What are your expectations?
We are expecting the RBI to deliver a 25 basis points cut in the repo rate.

What is your outlook on interest rates in FY13? Which are the debt fund categories that will outperform in a falling interest rate regime?
We expect the interest rates to remain volatile with a downward bias. We believe the rate transmission in the general economy will lag the rate reduction cycle as the system struggles to fight a liquidity deficit. The government borrowing programme will keep the private borrowers from getting credit at competitive rates as the benchmark rates are likely to remain at higher levels. The money market rates are going to closely track liquidity in the system. We believe that volatility of interest rates will give only brief opportunity to make money from long duration products and we expect short- to medium-duration products to outperform long duration products in FY13. Nonetheless, individual investors should take an informed decision in consultation with their financial advisors based on their investment horizon and risk appetite.

Assets under management (AUM) of most of the fund houses have dropped in the fourth quarter of FY12. According to you, what will be the outlook going forward?
A large chunk of AUM is in liquid funds, ultra-short-term funds and equity where all three have shown a decline in AUM. With entire FY12 being plagued with liquidity deficit, the fall was expected. We expect FY13 to be better than the FY12 as liquidity deficit reduces.

The first gilts auction of FY13 has devolved partially. What signal does it give to the market? What is the outlook on the yield on the ten-year benchmark?
The government borrowing is going to be a daunting task for FY13. The onus lies on creating demand for the same — this can be done by opening FII limits in government bonds, conducting OMOs (open market operations). We believe there is a demand-supply mismatch of around `1.5 lakh crore. This is a definite signal that benchmark government securities will remain at elevated levels for some time to come. We believe the supply will keep the yields checked at lower levels. The expectation that repo rate will move down by more than 75 basis points in FY13 is now looking challenging. Thus, we expect the ten-year bond to remain at 8.5% levels for an extended time. The likelihood of the ten-year bond moving down significantly is contingent on a sharp slowdown in inflationary pressures and consequently demand side pressures cooling off to below trend levels - this scenario seems to have a low probability.

What is your outlook on corporate bond issuances in FY13? What are your expectations for the spread between gilt yields and corporate bond yields?
We expect the PSUs (public sector undertakings) to come with regular issuance in three- to ten-year segments and keep the market well-supplied. In the five- to ten-year (AAA credit rating) segments of the curve, the current spreads have shrunk to 80 to 90 basis points from a mean of 120 to 130 basis points. We expect the spread to largely remain in a band of 70 to 100 basis points. In the three-year segment and below, we expect the spread to remain in a band of 110 to 130 basis points.

Banks continue to borrow heavily under the daily liquidity adjustment facility (LAF) of the RBI. By when do you expect liquidity to improve?
With the government typically spending close to 20-25% of total expenditure in the first three months and incremental credit growth slowing down in the slack season, we expect the liquidity to improve substantially. We expect that with an average monthly expenditure of `1 lakh crore to `1.25 lakh crore, the LAF deficit can turn to positive by September 2012. A caveat to that could be the domestic funding of the foreign currency convertible bonds (FCCB) redemptions can increase the credit growth along with a robust government borrowing.

With the economic growth slowing down, it is expected that there will be more ratings downgrades. In such a scenario, will the universe shrink for debt fund managers when it comes to buying papers?
This process of universe shrinkage started from FY09 for the fixed income fund managers. The fixed income fund managers now hold relatively stable sectors, and, to be more specific, stable companies in their portfolios. A large part of the portfolio is in the banking sector which is a well-regulated sector. No doubt, the current economic environment will further shrink the universe, but till the process of deleveraging in the economy takes place, it would be wise to choose from a smaller credit universe or collateralised structures.