Liquidity on the yield curve is certainly polarized to the 10 year segment: Suyash Choudhary

Interview with Head-Fixed Income, IDFC Asset Management

With the uncertainty of the US Federal Reserve raising interest rate over Suyash Choudhary, Head-Fixed Income, IDFC Asset Management in an interview with Tulemino Antao on the trends in the Indian rupee, bond yields and fixed income instruments

What is your medium term outlook for the Indian rupee in wake of the strengthening dollar post the historical rate hike by the US Fed?

The Indian rupee is likely to maintain its ‘low beta’ status with respect to other emerging market currencies. This means that its moves should be more contained versus many other emerging market peers. In our view this is on account of two factors: One, from a flow perspective our current account deficit is now fully financed by net foreign direct investments. Hence, our reliance on the volatile component of capital flows is now much lesser. Two, the credibility of our public policy is now very well established. In particular the RBI’s CPI targeting framework is a strong source of comfort with respect to the Indian rupee.

Bonds yields have been range bound post the announcement of the US Fed rate hike last week. What trends do you see for the bond yields in the last quarter of the current fiscal?

The mid to long end of the bond curve has been very sticky for most of this year, despite 125 bps rate cuts from the RBI. In our view, this is owing to a mismatch between demand and supply even as the underlying macro-economic environment remains very bullish for interest rates. The most obvious way this mismatch can be rectified is for the RBI to step up open market purchases of bonds. The justification for such purchases can be sought either from perspective of reserve money creation (since forex asset accretion has again slowed down lately) or from ensuring that sustained transmission of previous rate cuts happens (since banks cannot continue transmitting if risk free curve refuses to budge). However, pending such action from the RBI we expect the yield curve will retain a steepening bias. For this reason, we believe that performance drivers have shifted to the 5 – 9 year part of the yield curve.

Is there interest in maturities other than the 10-year benchmark government bonds? Is there scope for the RBI to develop the yield curve?

Liquidity on the yield curve is certainly polarized to the 10 year segment. For that reason many other parts of the curve develop substantial ‘kinks’ as market assigns a hefty illiquidity discount to these bonds. There is certainly a case to create better liquidity across the yield curve so that there is better reflection of only the ‘term premium’ and not ‘illiquidity discounts’.

With equities remaining volatile what are the trends seen with regards to inflows into mutual fund debt schemes for the industry and for your company since the second quarter (July-Sep) of the current fiscal till date?

Debt funds remain a compulsive story most simply since, with a dramatic fall in average inflation, investors can earn real positive returns from such funds in a relatively non volatile fashion. Reflecting this understanding, the industry has seen robust flows into debt.

Among other fixed income instruments What is your take on commercial paper and corporate bonds? Are there any corporate bonds worth investing at current levels?

We would strongly advise that investors take particular care of credit quality when investing in fixed income instruments. The current environment of slowing nominal GDP growth rates and falling commodity prices in context of a significant historic leverage cycle is squeezing debt servicing capabilities. This is evident in yields on certain sectors in developed markets, where credit is much more dynamically priced. However, the markets in India are much less developed and adequate price discovery is an issue. Hence, it can be argued that financial stress is not getting adequately captured in many lower rated papers simply because there is no secondary market for such paper where adequate price discovery may take place.

With interest rates on the decline what percentage of one's portfolio can an investor allocate to debt and which category of debt schemes would you advice new investors?

One should construct one’s asset allocation basis risk appetite and investment horizon. Therefore, there isn’t any one size fit all, either for existing or new investors.