Wait and watch policy for debt markets: Jajoo

 
Fixed income markets were in a free fall last week. Persistent weakness in the rupee (a new life-time intra-week low of 62 with eventual closing for the week at 61.71), further restrictive measures by RBI for moderating imports, high cut-off at weekly cash management bill auction (11.94% for 34 days) and further spike in 10-year US treasury yields to 2.80% led to very weak sentiments. The benchmark 10 year government bond yields were up a whopping 75bps to 8.88%. One year bank certificates of deposit rates were up almost 100 bps to 11% and 10 year AAA PSU bond yields hit double digits at 10%. Equity indices fell over 4% on Friday as markets interpreted the fresh measures by RBI, of restricting individual overseas investment limit to $75,000 vs $200,000 a year and corporate investment limit to 100% (vs 400% currently) of net worth under automatic route, as quasi capital controls, even though the finance minister took elaborate efforts to explain that it was just a small adjustment to current regulations. Fears of fresh FII selling and resultant pressure on rupee and liquidity lead to a fresh sell-off in debt markets also.

The index of industrial production (IIP) for June 2013 came at -2.2% with all segments except consumer non-durables showing negative growth suggesting a broad base contraction. CPI for July was at 9.64%. WPI for July was sharply higher at 5.79% with food prices registering a 12% increase. Trade balance was largely unchanged at $12bn but with a sharp rebound in oil and gold imports. The sharp increase in WPI takes away any hope of any respite in the near term on interest rate front.

With the sequence of events in the preceding two weeks, markets are now gearing for a sustained period of higher short term rates. Five year NRI deposits are now pegged at 13% a year after adjusting for forward premiums suggesting that there is still room enough for domestic rates to inch up. Banks which were reluctant to issue fresh CDs hoping for the tighter liquidity to be short lived are now hitting the market with sizable fresh issuances, explaining the sharp increase in CD rates this week.

At this point, sentiment remain extremely negative with little visibility on the way out of difficult current account deficit and lack of confidence that the measures by authorities so far to reduce volatility in currency markets will be effective enough. Though valuations have accordingly reached multi-year lows, fears remain that valuations may get still cheaper. One has to adopt a wait and watch policy and wait for more clarity to emerge before taking a more decisive stance. Those who expect that the government’s recent measures will have impact over the next few months and situation will restore to a more orderly one, may though start accumulating slowly from current levels. There is also a possibility, after the sharp correction this week of a small rebound.

Mahendra Jajoo is Executive Director & CIO-Fixed Income at Pramerica Asset Managers