Gilt funds facing more pain on inflation risks

Mutual funds (MFs) targeting government debt will probably see more pain after four straight months of outflows, according to Peerless Funds Management Co, as inflation risks dent the outlook for monetary easing.

Investors pulled Rs 840 crore ($126 million) from so-called gilt plans in May, data from the Association of Mutual Funds in India (Amfi) showed. That took withdrawals in the last four months to Rs 2,850 crore, the longest stretch since June 2014. The "surprise" acceleration in consumer-price gains to a three-month high of 5.39 per cent in April made "the future trajectory of inflation somewhat more uncertain," Reserve Bank of India Governor Raghuram Rajan said Tuesday as he left benchmark interest rates unchanged.

Credit Suisse Group AG, Australia & New Zealand Banking Group and Nomura Holdings Inc don't expect the central bank to cut rates in 2016, as a looming salary increase for civil servants and rising oil and food costs pose risks to its inflation target of five per cent by March. Rajan left the key repo rate at a five-year low of 6.5 per cent on Tuesday, but said the "stance of monetary policy remains accommodative."

"Bond funds will continue to bleed for some more time," said Killol Pandya, Mumbai-based head of fixed income at Peerless Funds, which oversees Rs 990 crore. "Much of the party on rates easing is done with and hence there isn't any meaningful room for capital appreciation."

A three-month rally in India's 10-year sovereign bonds ended in May as foreign holdings of rupee-denominated government and corporate notes dropped by Rs 4,860 crore during the month, the most since February. The yield on the notes maturing in January 2026 has climbed five basis points since the end of April to 7.49 per cent. It was steady on Thursday.

"Flows into government-bond funds will be uncertain," said Soumyajit Niyogi, associate director at India Ratings & Research Pvt, a unit of Fitch Ratings. "Given the risks to inflation, the room for the central bank to cut rates is rather limited."