MUTUAL FUNDS

Current Market Conditions Are Likely To Benefit Investments in Duration Funds<
02-May-13   10:07 Hrs IST

Mr.Rahul Goswami
Shorter end of the yield curve has been sluggish on account of low spending by the government and tight liquidity has kept short term rates firm. Going forward, with increase in government spend, we expect the liquidity to improve. says Rahul Goswami, Chief Investment Officer - Fixed Income at ICICI Prudential Asset Management.

In an interview with Capital Market, Rahul Goswami said, With expectations of rate cuts and OMOs that RBI is likely to conduct, we expect the short term rates to ease out from their current levels

Excerpts:

1. Reserve Bank of India (RBI) has cut the repo rate by 25 bps. What are your views? Do you expect a further rate cut by RBI?

Interest rate cuts are 'a shot in the arm' to reverse slowing domestic growth rate and fall in inflation. In the light of moderate inflation and decelerating GDP growth, RBI's policy announcements in March were along expected lines with 25 bps cut in the Repo rate and CRR remaining unchanged.

As per the Economic Survey released in February 2013, India's GDP is expected to grow at 5% in 2012-13, the slowest in nearly a decade and significantly lower than the growth rates of 6.2% and 9.3% achieved in 2011-12 and 2010-11 respectively. Inflation (as measured by the Wholesale Price Index) has fallen to a 40-month low of 5.96% in March 2013. The RBI in its latest monetary policy review held in March warned that high current account deficit (CAD) and inflationary expectations limit the possibility of further rate cuts. Inflation has dipped while CAD is expected to decline due to a sharp drop in gold and crude oil prices in recent months (these two commodities are among those that form the largest components of India's imports). International gold prices have declined 11% in the past year to $1,472 an ounce on the London Bullion Market Association as on April 26, 2013. It had touched a recent low of about $ 1380 per ounce on April 16th. Brent crude oil prices have declined 14% in the past year to below $103 per barrel before touching $ 97.69 per barrel on April 17th. All these events indicate more space for monetary easing measures from RBI in times to come.

2. RBI has expressed concerns over high CAD as this can threaten macroeconomic stability and impact growth. Kindly share your views on the rising CAD and its effect on RBI's decision to further cut interest rates.

In its last monetary policy review held in March, RBI warned that high current account deficit (CAD) and inflationary expectations limit the possibility of further rate cuts. In line with our expectations, the trade deficit (which typically forms a large constituting portion of CAD) for March narrowed to US$ 10.3bn (6.7% of GDP annualized) versus US$ 14.9bn (9.7% of GDP annualized) a year ago. Going forward, we expect current account deficit to come down sharply from $6.7 percent of GDP to around 3.2%-3.4% of GDP. The factors that will aid in bringing down the CAD include (i) gradual improvement in external demand from the second half of 2013 to further improve export growth, (ii) recent government efforts to cut fuel subsidy burden to help moderate oil imports (iii) softening commodity prices and (iv) moderation in CPI inflation which will be critical to reduce gold imports.

3. What is your opinion on the currency movement? How has it affected the bond market and liquidity in the system?

The flows are typically higher during the January to March quarter as compared to the other months of the financial year. Higher export growth in the January to March quarter has ensured that the rupee does not weaken. However, if the portfolio / FDI / trade flows deteriorate in the April to June quarter, we believe this may lead to a reasonably high probability of the dollar appreciating against the rupee. We may witness the rupee trading at 56-57 against the dollar in this quarter itself. The view is based on the premise that no major crisis is expected to break out globally. However, even if things remain uncertain, volatility is likely to continue. In terms of policy, we expect that RBI may tinker with the HTM for government securities; however, we don't expect it to have an impact on the market. RBI is likely to ensure that no policy decision adversely impacts the economy, which, in turn, may be transmitted to other segments of the markets such as a dollar/rupee imbalance, or upheavals in the money market or the government securities market.

4. Where do you see the benchmark 10-year G-Sec yield in the next three months?

We expect the benchmark 10-year G-Sec yield to trade in the range of 7.35%-7.65% in the next quarter.

5. What is your outlook for corporate bonds in FY14? Will corporate bonds move in tandem with G-sec yields?

Generally corporate bonds move in tandem with G-sec yields. Also there could be some amount of narrowing of spreads depending upon the amount of supply of corporate bonds.

6. What is your view on the short term rate movement?

The shorter end of the yield curve has been sluggish on account of low spending by the government and tight liquidity has kept short term rates firm. Going forward, with increase in government spend, we expect the liquidity to improve. With expectations of rate cuts and OMOs that RBI is likely to conduct, we expect the short term rates to ease out from their current levels.

7. At the current juncture, which category of debt funds would you recommend to the retail investors?

We believe current market conditions are likely to benefit investments in duration funds such as Income and Gilt Funds with 12-18 months' horizon. Investors should keep in mind the volatility associated with duration funds. Investors can also seek to benefit from reasonable risk adjusted returns in the near term from investments in ICICI Prudential Regular Savings Fund, ICICI Prudential Corporate Bond Fund and ICICI Prudential Short Term Plan. Investors looking for a balance between reasonable accrual and capital appreciation can consider investing in ICICI Prudential Dynamic Bond Fund with an indicative investment horizon of 9 months and above. Also investors with a horizon of 2 to 3 months may consider ICICI Prudential Ultra Short Term Plan. We strongly recommend that investors seek guidance of Financial Advisors to make sound investment decisions based on their risk and return profile.

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