We expect a 50 basis points cut in the month of April 2015 as inflation expectations comes down in the economy<
10-Dec-14   12:44 Hrs IST

Mr. Murthy Nagarajan

In an interview with Capital Market, Murthy Nagarajan, Head-Fixed Income, Quantum AMC said, The ten year yields should trade around 15 to 25 basis points over repo rates. We expect RBI to cut 75 to 100 basis point in Repo rates in the next financial year.


1. What are your views on fixed income market? How have the yields moved and which direction you see them moving in near to mid-term and why?

The fixed income markets are in a goldilocks type of movement, with Brent crude prices trading in the band of 78-80 USD per barrel vs 110 USD in the beginning of the year, Commodity prices like iron ore touch 72 USD per ton vs 132 USD at the start of the year, CPI food inflation touching a low of 5.82 %, Eurozone inflation at 0.4 %, U.S inflation at 1.3 % in the month of October 2014 even after US Federal Reserve, ECB, and bank of Japan money printing to stimulate growth and inflation in their respective economies. The U.S Federal Reserve has added 3.2 trillion dollars from 2008 onwards, but has failed to bring inflation to 2 % for the last 21 months.

In the Indian context, CPI inflation touched a low of 5.52% in the month of October 2014; this is the lowest inflation data point from the start of the CPI index. WPI inflation touched a low of 1.77% in the month of October 2014. Chinese economy is slowing down due to falling property prices. The Chinese are also focused more on driving domestic consumption rather than rely on export oriented growth for their growth. Under the new regime, the trust is meet world carbon emission targets. The Chinese are closing down some polluting industries. All these activities would lead to lower demand for commodities. This should keep global inflationary environment subdued. India will be a big beneficiary of these developments and the CPI and WPI inflation for the next financial year is expected to around 6 % levels and 3% levels.

The ten year yields should trade around 15 to 25 basis points over repo rates. We expect RBI to cut 75 to 100 basis point in Repo rates in the next financial year. The yields are expected to trend downwards as RBI gets more confidence in meeting its 6 % inflation target by January 2016 and start cutting rates.

2. What reforms you expect for curtailing fiscal deficit and why?

For the past two years, the government has been curtailing the plan expenditures in the budget to meet its fiscal deficit targets. The government has also deregulated petrol and diesel prices. It is also planning to allow direct target of subsidies to the consumers to avoid corruption in the allocation of gas cylinder and kerosene which is prevalent in fair price shops. The government would also not allow the subsidies to given to well off section of the society. The focus on the present government on the manufacturing sector and purchase of defense equipment's in India would create additional revenue to the government. The government is also expected to introduce goods and services tax which could lead to higher tax revenues. The government would try to increase tax compliance and increase GDP growth in the coming month to increase tax revenue.

3. Kindly share your views on recently falling inflation? Is there possibility of inflation rising? Why?

The fall in inflation is due to sharp fall in vegetable prices, high base effect, and fall in petroleum products. The year on year growth of vegetable price inflation is negative 1.5 % levels, rice prices are also lower on a year on year basis, and the government offloaded 5 million tons of rice in the open markets in the month of August and September. The Retail inflation which was 10.2% last year also aided the fall of CPI inflation coming to 5.52% levels, with the food inflation coming at 5.82% levels. Brent crude prices have fallen by 20-25% from July when it was trading around 110 per barrel. This has led to petroleum product inflation coming down to negative 3.3% in the current financial year.

The next reading of CPI inflation is expected to be around 4.5% levels due to high base effects, fall in crude prices and global fall in food inflation and commodity prices. Subsequently, the base effect would reverse and we expect the next inflation reading to be around 6.5 %- 7%. Inflation is expect to remain at low levels as commodity prices are expected to be low, food inflation would remain under control as good rainfall in the month of September has made the overall deficit in rainfall at (-) 12 % levels compared with (-) 23 % level deficit. Manufacturing inflation is expected to be subdued as China is running overcapacity and has high inventory of finished stock in steel and many other commodities. The government is also expected to increase minimum support prices by 3 to 5 % in the coming years which should cap food inflation.

4. What's your investment strategy?

Our investment strategy is to have a higher maturity, with pre dominant exposure to government securities, as the spread between government securities and corporate bonds is in the range of 20 to 30 basis points.

5. When do you expect the RBI to reverse the policy stance and why?

We expect RBI to reverse its policy stance in the month of April. RBI wants the government to de clog the supply side bottlenecks in the economy; it would also look at the union budget and the fiscal deficit target which the government is targeting and its achievability before cutting rates. RBI would take cognizance of the current account deficit in the next financial year as the U.S Federal Reserve is expected to increase interest rates in the next calendar year. Accordingly, we don't expect RBI to cut interest rates till April 2015. We expect a 50 basis points cut in the month of April 2015 as inflation expectations comes down in the economy.

6. What is your advice to the investors?

Investors who have a one to two year investment horizon should be invested in long term debt funds to take advantage of falling interest rates in the economy. Investors who have a holding period of less than one year but more than 6 months can invest into short term funds and investors who have three months to 6 months holding period can invest in income plus funds.

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