‘Govt borrowing will keep bond yields elevated’

Short-term rates are likely to remain high. Why? Because the Reserve Bank of India (RBI) is expected to be cautious in cutting rates. So believes Vikrant Mehta, head of fixed income at AIG India Asset Management Company. In such a scenario, he says, duration products like short-term funds are likely to continue to find favour with investors. In this interview with Neelasri Barman, Mehta talks about the path ahead for the debt market in FY2012-13 beginning tomorrow.

How should one evaluate investment in debt funds in FY13? Given the ever-changing economic environment, do you think retail investors need to re-balance their debt investment portfolio frequently?
Since debt funds invest in debt securities or assets whose prices rise or fall daily, the market value of debt fund investments, too, fluctuates every day. People need to understand that their allocation to debt should be to get reasonable returns with the added incentive of superior tax efficiency (under the current tax norms), and not for capital gains which can ideally be captured by equities and / or commodities. It will be prudent to wisely evaluate investment in debt funds, especially more so in a growth economy like India, where interest rate cycles are short and yield movements can be volatile and brutal.

With the world having dramatically changed post the global financial crisis of 2008, uncertainty and the unexpected are more the norm than exception. Thus, instead of timing the market, one would be better off aligning towards a debt product which would address the investment horizon of the individual. There are fixed-income funds with preferred investment horizons varying from one day to a few years and also products with both passive and active management strategies, depending on one’s risk appetite.   

The government will announce a bulky first-half borrowing calendar for FY13. What will be its impact on gilt yields?
The government will be borrowing Rs3.7 lakh crore in the first half of the fiscal year. This is about 65% of the gross borrowing programme and slightly on the upper side of market expectations.  Markets have reacted unenthusiastically to this borrowing number, driving the yield on the benchmark 10-year GOI (government of India) bond up by 12 basis points (100 basis points or bps = 1.00%) to 8.62%  on March 28, 2012, the next trading day post the announcement of the borrowing calendar. The practically unabated issuance of sovereign bonds beginning the first week of April 2012 is likely to keep GOI bond yields elevated and under pressure. 

What is your current investment strategy for the AIG Short-Term Fund?
Debt funds invest with an objective to realise reasonable returns commensurate to the risks. The AIG Short-Term Fund (an open-ended income scheme) leans towards instruments and credits with low impact costs and high tradability, which enables the fund to take advantage of opportunities provided by the markets. Over the past few quarters, money market yields were significantly higher, compared to yields on medium- to long-term maturity bonds. Thus, AIG Short-Term Fund saw value in being at the shorter end of the curve. The high yields, especially in the bank certificates of deposit (CDs) space, coupled with their advantage of high liquidity and tradability, provided AIG Short-Term Fund the opportunity to deliver competitive returns with a lesser amount of risk. With long bonds likely to underperform in the short to medium term, and with short-term yields liable to remain relatively high, we see no reason to change our current strategy.

What is your outlook on inflation in FY13? What are the key concerns?
Inflation is likely to average between 6.50% and 7.50% in FY13. Brent crude is currently hovering around $125, according to Bloomberg data. With domestic oil prices reflecting suppressed inflation, any upward revision in domestic crude prices poses upside risk to inflation.

When do you expect the RBI to cut the repo rate, and by what extent? Do you think the RBI will take a cautious stance?
Circumstances are appropriate for the RBI to consider a 25 bps reduction in the April monetary policy review. High global oil prices and the large fiscal deficit for FY2013 have tempered expectations of a large reduction in the repo rate. With control of inflation continuing to remain a priority, the RBI is expected to take a more calibrated stance in cutting rates over the next 12 months. Given the current situation, I am hopeful of the RBI looking at a 75 bps repo rate cut during FY2013. 

Fund houses launch many fixed maturity plans (FMPs) in March. What kind of response has the industry received this time? Why should retail investors consider investments in FMPs?
FMPs provide superior post-tax returns, compared to many alternative competing products. Multiple indexation benefits, depending upon the maturity, have further added to the allure of these products. To maximise these advantages, March typically witnesses a large number of FMP launches. This March, with money market yields at almost multi-year highs, the response to FMPs has been more than encouraging. However, it is pertinent to note that while FMPs are tax-efficient under the current taxation norms, the investor may have to compromise on liquidity.

Which debt fund categories will be in vogue in FY13?
With the RBI expected to be cautious in cutting rates, short-term rates are likely to remain elevated. Thus, duration products like short-term funds are likely to continue to find favour with investors. Dynamic bond funds can be a suitable vehicle for those with higher risk-taking ability. Investors with limited appetite for volatility might be inclined towards FMPs and ultra short-term funds. 

What is your outlook on liquidity?
Liquidity deficit reached almost Rs2 lakh crore towards the end of March 2012. This is almost three times the comfort zone of the RBI. Year-end spending by the government and the return of advance tax monies to the banking system are likely to infuse liquidity into the system. The overhang of the large government borrowing will prompt the RBI to use a mix of both CRR cut and quantitative easing in the form of OMOs. This will ensure a successful completion of the sovereign borrowing calendar and address concerns on crowding out of the corporate sector from the credit market.