Reserve Bank of India (RBI) in an unexpected move reduced repo rate by 25 basis points (1 basis point is 1/100th of a percentage point) while changed policy stance to neutral. The repo rate is the rate at which the RBI lends to other banks in India. The rate hike cycle that started last year has ended with this move. We spoke to Devang Shah, Deputy Head -Fixed Income at Axis Mutual Fund, to decipher the RBI policy decision and understand undercurrents of debt market. Excerpts:
What is your take on the RBI policy announcement?
RBI appeared dovish. The overall inflation outlook and policy stance indicates that RBI is focusing more on growth. As the current inflation of 2.19% (as on December’18) was much lower than RBI’s target of 4% we think it was prudent focusing on growth at this point in time given the inflation target is achieved.
Market experts were not expecting a rate hike in this policy meeting. Do you think this rate cut was warranted?
RBI as a central bank has a primary target of controlling inflation. And once that is achieved it can look at growth-oriented policy approach. I think this step of reducing the repo rate is significantly supportive of growth.
Do you agree with RBI’s Inflation and growth projections?
Our sense is that growth rate between 7 -7.4% is quite good. If we compare this growth rate with other developed and emerging economies, we believe we are a fastest growing economy. We think and our regression analysis shows that inflation might start going up in June-September quarter and is likely to reach levels of 4-4.5%.
RBI has revised the inflation forecast downwards. Would the fiscal slippage pose upside risk to this projection?
RBI has taken in to account the fiscal slippage in inflation calculation. Central bank believes, the fiscal slippage of 10 basis points (from 3.3% earlier commitment to 3.4%) would have minimal impact on inflation of about 10-15 basis points. Thus, RBI doesn’t view it as a significant upside risk.
We just experienced a very short rate hike cycle – merely a year wherein there were two rate hikes of 25bps each. How long will the rate cut cycle last? How much do you think the repo can go down from here?
As I said earlier, we are expecting the inflation to increase in June-September quarter to the tune of 4-4.5%. In that case I don’t think there is much room for RBI to cut rates. So, I think we could possibly see one more rate cut of 25 basis points and that would be it. Overnight rate of 6% seems reasonable. Unless the inflation significantly surprises on the downside it would be difficult for RBI to deliver more rate cuts.
What is the way forward for debt funds from here? Do you think high duration funds or dynamic bond funds would start receiving higher investor preference? Which schemes are likely to garner more business?
In terms of long duration bonds, additional supply of Rs 33,000 crore has been added owing to the fiscal slippage. RBI also cited that liquidity in the economy is close to neutral therefore we will not witness large OMOs (open market operations by RBI where it buy and sells government securities and treasury bills to manage money supply) in the next year – we have had OMOs of about ~Rs 2,70,000 crore this year.
Thus, I don’t see significant rally from current levels. We can have a small tactical rally of about 10-15 basis points but lack of clarity on OMOs, volatility in crude prices and front ending of G-sec borrowing in the first half of next fiscal year will keep long duration bonds range bound.
Whereas short duration AAA (triple A) bonds are currently trading at a spread of ~150bps spreads over repo rate. Also, credit spreads – AA bonds (double A) over AAA are around ~150-200 basis point. While there are noises in the credit market pertaining to certain issuers, we don’t see any significant deterioration happening in credit cycle at large.
Thus, according to me short term funds with selective allocation to credit funds offer better returns from a risk-reward perspective. And these are the schemes which would attract more business as well.
What is your strategy for managing debt funds at Axis MF?
Our core positioning will be building in short bond space. The long bonds can offer tactical rallies however as there will be limited rate cuts & unfavourable demand supply dynamics, we don’t see a significant play on long bonds. Also, growth inching up and volatile crude prices pose upside risk to this strategy. The short-term bond space can offer attractive returns and are good from risk–reward perspective in current scenario.
Thus, my advice to investors would be to invest in short term funds along with small allocation to credit funds. And that would be the core debt outlook at Axis Mutual Fund
What would be your advice to the investors who wish to invest for long tenors of 3-5 years?
For investment tenure of up to three years also I would suggest short term mutual fund schemes. We suggest long term bonds when we envisage a significant rate cut cycle. At this point in time we believe that rate cut cycle will be shallow and hence long duration funds won’t be a viable option for investors. Investors can choose from short–medium duration funds along with credit risk funds from a 3-5 year investment perspective.