Inflation, rates hikes may push yields up further: DSP Investment's Yadav

In a Q&A, the head of the fixed income vertical at the firm says the 10-year benchmark rising above 7% is normal and not a sign of instability

After the spike in inflation and rate hikes by other central banks, the Reserve Bank of India's (RBI’s) rate hike was fait accompli, says Sandeep Yadav, Head–Fixed Income, DSP Investment Managers. In an interview with Ashley Coutinho, he says the quantum and duration of rate hikes would be driven by the inflation trajectory going forward. Edited excerpts:

What do you make of the recent announcement by the RBI to raise the repo rate by 40 bps and CRR by 0.5 per cent?

After the spike in inflation and rate hikes by other central banks, RBI’s rate hike was fait accompli. It is a defensive action – even though a surprising one. We certainly expect the yields to harden and RBI to further hike the rates. The quantum and duration of rate hikes would be driven by the inflation trajectory going forward. My view is that inflation would continue to remain elevated, making it necessary for RBI to hike rates significantly.

India's benchmark 10-year bond yields have surged above 7 per cent in the past few weeks. How do you see the trajectory going forward?

The 10-year benchmark rising above the 7 per cent levels is quite normal and should not be taken as a sign of instability. After all the underlying macro-economic data has worsened significantly and the bond yields are just reacting to the data. I expect the yields to harden further necessitated by the rising inflation, worsening CAD and large fiscal borrowing. In fact, India’s 10-year benchmark yield has usually been higher than the current levels  barring the periods coinciding with the global financial crisis, demonetization and the Covid pandemic.

What is your take on the spike in inflation? Is it more structural in nature and similar to what some developed economies are experiencing right now?

Some may argue that India’s inflation is driven by food and fuel prices. While that may be true, if inflation remains entrenched then it finds its way to core demand inflation. Even a supply driven inflation can increase consumers’ inflationary expectations and then percolate to the demand inflation. Even RBI’s minutes from May 2022 MPC has touched on the fact that inflation is becoming broadbased and the inflationary expectations need to be controlled. It will be interesting to see RBI’s next consumers’ inflation expectation survey to determine whether India is following the same trajectory. To summarize, a consistently high supply driven inflation risks becoming structural inflation.

What is your view on the trajectory of interest rates globally? Will it accelerate the flight of foreign money from India?

Globally interest rates should continue to rise, though the fears of recession would likely cap the rise in longer tenor yields. I do not expect a flight of foreign money from debt as current debt holdings are already quite low, and the residual debt holdings should be sticky. In equity we are already witnessing outflows. More than the flight of money, I am concerned about the inflow of foreign money. India’s Current Account Deficit is funded through Capital Account Surplus. Since Oil prices are expected to remain high, the CAD is expected to be large. If rising global yields restrict the capital account inflow then that is worrisome, especially for the currency.

What are the kinds of debt products that investors should look at right now?

For the time being investors should prefer to remain in the shorter duration products with up to 1 year duration. While the yield curve is still steep and the longer maturities give much higher carry, the markets are volatile and the higher carry may not be able to insulate the yield rise. Even though the curve may flatten, a long-term investor should rather remain invested in a shorter duration for time being. We have witnessed only one rate hike by RBI. It is prudent to wait and see how the inflation data unfolds and how RBI reacts. The yields are not going to ease in the near future, and it is better to be patient than invest in a hurry.

Credit risk funds as a category have given returns of 15 per cent for a one year period. Is it a good time for investors to look at these funds?

Some credit risk funds' recent performance may be due to past recovery, and not purely as a part of returns from current investment. Thus, one needs to be aware of the return numbers. Many companies and sectors are in a good stead currently – nonetheless these funds do carry a risk. Investment in credit risk funds is dependent upon the investor's risk appetite, rather than just timing.

Do you see more corporates lining up to raise funds from the bond market this year given the expected revival in the capex cycle?

I do not see signs of the capex cycle reviving meaningfully across sectors. While some sectors have seen an increase in capex – but these are lumpy investments and are not representative of the larger economy. The global markets are expected to go into recession, and India’s growth and demand may taper. Until there is a durability in the capex investments, I find it unlikely that we will see many companies lining up to raise funds from the debt markets.