MUTUAL FUNDS

We believe that RBI could cut the repo rate by 50 bps in Q1 2013<
08-Jan-13   10:16 Hrs IST

Mr.Arvind Achari
From an investment perspective, we would prefer longer tenor duration funds over fixed deposits and FMPs at least till the first half of the year. says Arvind Chari, Senior Fund Manager (Fixed Income) at Quantum Asset Management Company Private Limited.

We at Capital Market interacted with Arvind Chari to now the outlook on debt markets for the year 2013.

Excerpts:

  1. Regarding debt funds, since there is still a fair amount of uncertainty with regards to the precise timing of the interest rate cuts as we head into 2013, how do you approach debt funds now? Is it better to put your money in some of these open ended funds or do you think you would still stick to some fixed maturity plans (FMP) or even fixed deposits?
  2. We believe that RBI could cut the repo rate by 50 bps in Q1 2013. From that perspective long term bond yields can soften further even from their end December 2012 levels. This would make open ended debt funds an ideal short term tactical choice to play the rate cutting cycle as against FMP and FDs

  3. What levels do you foresee for the 10 year benchmark government securities during 2013?
  4. Under normal market conditions (comfortable liquidity and reasonable market supply), the 10 year bond usually trades between 15 and 30 bps above the repo rate. If the RBI cuts the repo rate by 50 bps to 7.5%, then the 10 year could move to a 7.65% - 7.80% range in the very near term. If headline inflation eases closer to 6% and stays there, the RBI then would be able to cut the repo rate by at least 100 bps in the year and this would ensure that the long term bond yields can fall even further during the year.

  5. What's your outlook on fixed income markets for 2013?

One big risk for the market is if inflation remains sticky in 2013.  This attains significance when seen in the context of the quantum/amount of rate cuts expected in 2013. If WPI inflation remains sticky around the 6.5% - 7.0% range and core inflation remains above 4%, it would be difficult for the RBI to cut interest by more than 50 bps during the year. We did see in 2012 that WPI inflation remained higher than the comfort level for almost the entire year and stubbornly prevented the RBI from cutting rates despite the growth slowdown. In fact such was the wedge in the growth-inflation trade-off that in its October 2012 policy, RBI lowered its own GDP forecast to below 6% but still refrained from cutting interest rates.

The other obvious risk is fiscal deficit; even if the fiscal deficit is kept below 5% in Fy 14, it would still lead to high gross borrowing by the government in the first half of the fiscal. If RBI rate cuts and OMO support do not materialize, we could see bond yields inch up during the April - September period

But given that we expect headline inflation to ease and RBI to cut rates, we expect bank lending and deposit rates to fall from their current levels. Investors, who have enjoyed double digit deposit rates in the last 2 years, should expect deposit rates to moderate towards the 8% mark during the year. At the same, bank base rates (lending rates) should also fall giving relief to floating rate home loan borrowers.

From an investment perspective, we would prefer longer tenor duration funds over fixed deposits and FMPs at least till the first half of the year.

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