We expect a further easing of 25 to 50 bps during the remaining part of FY 2017

With reduction in small savings interest rates beginning this fiscal year, many investors, especially senior citizens, who rely on FD interest for their incomes are worried. What is your advice for investors who rely on fixed income investment for their income?

With the current cut in the small savings rates, expected fall in deposit rates and RBI's move in the Policy to make banking system liquidity positive, savings rate under various traditional avenues such as deposits will decline gradually.

With expected decline in repo rates further by 25-50 bps and improving liquidity conditions, we expect bull steepening of the yield curve. Essentially the quantum of decline in rates may be higher at the short end (1-5 years), but the absolute amount of capital gains at the longer end of the yield curve will compensate.

Carry (yield on investments) will be a big driver for investment allocation decisions as overall rates come down. The gradual rebound in growth, decline in interest costs and government policy led intervention will improve corporate balance sheets both from a leverage and cash flow perspective. This will create attractive investment opportunities for investors in the private sector corporate bond space.

To capture these attractive investment opportunities, in the form of conservative allocation in debt mutual funds, investors should look to allocate in moderate duration high accrual funds like Reliance Regular Savings Fund (RRSF Debt) and Reliance Corporate Bond Fund. These are mixed grade portfolios, where alpha creation happens through debt exposures to well researched private sector companies. These funds aim to generate tax efficient stable returns over an investment holding period of 3 years & above. These funds are ideal for those investors who are looking for a superior alternative to traditional investment options.

Alternatively, investors may also choose to allocate to long-term close ended funds (Fixed Maturity Plans), which helps them capture the current attractive yields in the PSU as well as corporate bond space. Investors staying over three years will also get attractive indexation benefits which enhances the returns on a post-tax basis.

The element of capital gains may be the highest in longer duration funds such as Dynamic Bond Funds and Gilt Funds, but the investors need to factor in interim volatility and come into these funds only if the time horizon of investments is 18 months and beyond.

CPI surged to 5.76% in May, mainly on account of food price inflation. What in your view are the factors underlying the (more or less) persistently high food price inflation in our country? Do you see food price inflation moderating in the coming months with, hopefully, good monsoon?

Food inflation has seen a higher than expected seasonal spike this year. This is primarily driven by Pulses and Vegetable prices. On the other hand the cereal and other staple food prices are more stable owing to lower MSP increases done by the government over the last few years.

Food inflation is more about supply management than monetary policy. The government has done a good job in terms of supply side measures including imports, duty on exports, releasing buffer stocks to tackle these shortfalls in demand supply. And we have seen it showing positive results in cases like Onion, Sugar etc in the past. We believe in the government’s ability as well as intent to follow up similarly in case of pulses. Vegetable prices will show a seasonal decline over the next 3 -4 months.

Good monsoons will help definitely and that impact will show in the second half as far as overall food inflation is concerned.

What’s key to note is that during all this volatility in food prices, core inflation has remained very stable at lower levels of around 5%.

Crude prices have re-bounded from the January – February lows. Are there significant near term risks of crude prices affecting inflation and fiscal deficit in India?

From the highs of more than $100 a barrel crude oil declined all the way to below $30 and is now hovering at around $50. So the net decline has been substantial from the perspective of a large impact on inflation well as fiscal deficit. Any ways, since the government is passing through the price changes in petroleum products on a fortnightly basis, the fiscal deficit equation does not change when the price changes unless the government changes its policy of pass through. The oil price pass through is possibly the single largest fiscal reform that has been carried out in the last few years.

The risk on inflation is also minimal as long as crude stays below $60-$65 as the savings would still be substantial. Moreover the direct impact of a change in crude prices is not significant as far as CPI is concerned. It’s the indirect impact which will be felt through transport and service inflation over a period of time, if the crude prices were to rebound substantially over the $60 - $70 range.

What is the implication of Brexit on the Indian economy, both in terms of exports and our currency, in near term and the medium term? Once the slightly longer term implications of Brexit plays out, do you expect it to cause a chain reaction of non USD currency devaluations?

The size of the British economy is relevant but not substantial in global terms. The trade impact on India is minimal and hence has no direct bearing even if the British economy slows down post Brexit.

However the Brexit impact will be felt in economic terms over a longer period of time, which will be driven by the political fallouts. The larger fear being that Brexit will drive more Eurosceptic leaders across the Eurozone to take a harder stance vis a vis EU. That kind of a scenario may be more damaging for global trade and growth and can’t be factored in right away in terms of precise numbers.

In terms of currency, any further slowdown in global trade, as well as competitive devaluations by larger central banks would put pressure on the EM space, India being no exception. The relative scale though is much more favourable for India for two reasons. One, it’s one of the few global spots which has very respectable endogenous growth, driven by demographics, need for infrastructure creation and demand. This in turn will drive in disproportionate global capital allocation to India. Two, from an EM standpoint, it has very favourable macro parameters, and those will get strengthened further in a low commodity price, low inflation, fiscal discipline environment.

The US Federal Reserve did not raise interest rates in their last monetary policy announcement. With Brexit behind us, when do you expect the Fed to increase interest rates?

The spread between India (bond yields) and developed markets has widened significantly. For example, from an average of 300-350 bps spread between India and US benchmark yields, the spread has increased to almost 700 bps in 2013. From there, now it has come down to about 600 bps. But, we are still much higher than the level we had seen in the last decade between 2002-2010.

If fiscal discipline, consumer price inflation and current account stay stable, you will see the gap between India and developed market rates coming down further. For foreign investors, a stable currency is an important reason for Indian markets to remain attractive especially on the debt side. You put money on debt for stability, not for growth.

A 7.5% rate (10 year GOI yield) with a relatively stable currency is an attractive proposition for overseas investors. If US Fed hikes rates by as much as 25-50 bps this year (which is a very low probability event post Brexit), it will have a short-term impact, but India will continue to remain insulated as far as our domestic macro remains stable. What matters more is the cumulative amounts of potential Fed Rate hikes over the next 12-18 months, which will be significantly lower (possibly not more than 50-75 bps) than what was envisaged at the start of the US rate hike cycle.

Do you see the Reserve Bank making more rate cuts this fiscal year? If yes, what is the quantum of cuts that you expect this year?

We expect a further easing of 25-50 bps during the remaining part of FY 2017. This will be driven by stable macros, the shift in focus to promoting growth, and the continued comfort with the government as far as fiscal discipline and adequate supply side responses for managing inflation is concerned.

Its worth highlighting that the bigger driver for rates during this financial year will be a combination of rate cuts and better liquidity conditions, rather than rate cuts alone.

Optics aside, do you expect the exit of the current RBI Governor to posing risks to the monetary policy challenges in India? What are the major monetary policy issues that the new RBI Governor will have to deal with?

For a country like India the main pillars of macro stability are fiscal discipline and low Inflation. In fact one could argue that inflation is an outcome of fiscal policies, which is a government prerogative. So while RBI did set that agenda, the government policies were the main drivers for bringing inflation down. In fact one of the best parts of the last 3 year journey of improvement in internal and external macros has been that the government and the RBI have been on the same page in terms of focus and priorities. All the substantive moves on the monetary side have not only been supported but in fact been complemented by the Government to ensure success.

This gives us a lot of confidence in believing that the path towards greater macro economic stability and better prospects for growth will continue under the present government. It's true that the market looked at the team of Mr Modi and Dr Rajan as a strong and potent driver for the India story, but we are sure that the government will choose a worthy successor to Dr Rajan, who will not only be strong in terms of credentials but also will carry forward the policies that have been initiated under Dr Rajan. India has had a tradition of strong and visionary people at the helm of RBI in the recent past and we are sure that trend will continue.

We also believe the government and the RBI will manage any such volatility (in terms of Brexit as already seen and FCNR outflows) effectively, in order to give confidence to investors, especially overseas investors.

What is your outlook on bond yields over the next 12 to 24 months?

The current debt market scenario is positive, with government’s commitment to fiscal consolidation plan, inflation settling at lower levels, RBI’s commitment to neutral system liquidity & an accommodative interest rate stance and relatively stable currency and other external market factors.

Along with the accommodative stance, the RBI has now clearly focused to enhance the existing liquidity framework. According to our view, the revision in the liquidity framework, cut in key policy rate (along with the alignment of small savings rates with market rates) as well as the implementation of the MCLR is expected to further facilitate transmission and in turn enhance monetary policy efficacy. Further management of durable liquidity through aggressive Open Market Operations (OMOs) is a big positive as far as lower bond yields are concerned.

The combination of better liquidity conditions, continued FPI flows, increased RBI demand for G-Secs, and more stable overnight rates is a positive development for the rates market, which could result in bull steepening of the rates curve.

With bull steepening, along with another 25 – 50 bps possible rate cuts, we expect varying parts of the yield curve to fetch attractive returns over the next 12 – 36 months, albeit at various point of time.

Long term gilt fund investors, including investors in your gilt fund, Reliance Gilt Securities Fund, have got around double digit returns in the last one year. Given your interest rate outlook, will you advise gilt fund investors to remain invested in these schemes over the next 2 to 3 years?

Long term duration funds would benefit over the next 12 -24 months from the fall in yields across the curve. We expect scope for further capital gains exists on further monetary easing. With this thought would advise gilt fund investors to remain invested over a period of 1-2 yrs.

For investors who want to capture these gains and continue to stay invested for a longer period of 3 years and beyond, the Dynamic Bond Fund would be a preferred vehicle, because it will reduce its duration meaningfully once the major part of the interest rate rally is over. This would help investors protect the gains made during the bull phase.