The rates market is once again at an important crossroads. While the money market yields i.e. yields of papers up to one year maturity are possibly on a downward trajectory, the yields of longer-dated bonds are possibly staring the other way.
While there has been a concerted effort by the finance ministry and the Reserve Bank of India (RBI) to bring down inflation, the Consumer Price Index-based inflation and the inflationary expectations continued to be a challenge for policy makers. While there has been some softening in the Wholesale Price Index-based inflation, the food inflation remains high and is pushing overall inflation upwards.
Nevertheless, due to a sharp drop in the economic growth over several quarters and concerns due to drop in export growth and a widening CAD (current account deficit), the behaviour of the currency has been disappointing. Due to the decline in the value of currency along with slowing growth and widening CAD, the rating agencies have started to raise concerns over the quarters and pushed the sovereign rating outlook to negative.
RBI has stepped in with a rate-decline strategy, armed with low core inflation. Apparently, interest rates are poised for a steady decline over the months. RBI has started again with a 50 basis points decline in the repo rate over the last two months in two tranches, after a 50 basis points drop in April 2012. The yields of shorter maturity assets are expected to move lower over the months with the reduction in repo rates by RBI. The shape of the yield curve might turn steeper in case the yields of longer bonds stay at the current levels in the light of the huge borrowing programme of the government. In order to improve the growth environment and bring about the investment demand back into work the twin strategies of lower fiscal outlays accompanied by a benign rate environment is being pursued by the finance ministry and RBI jointly.
The possible steeping of the yield curve is expected to work in favour of all short-term funds and active income funds maintaining a low to moderate portfolio duration. The steeping of the yield curve, with decline in money market yields, are expected to work in favour of possible capital appreciation over the following two-three quarters.
Importantly, a well-managed borrowing programme of the government through interspersed OMO (open market operations) by RBI should also do well in keeping the sentiment buoyant for a stable to declining rate environment for long bonds as well. Hence, a stable upward sloping yield curve should support the borrowing requirement of both companies and government.
Additionally, the more recent market- friendly guidelines for foreign institutional investment (FII) in Indian corporate and sovereign debt are expected to improve the demand for Indian assets and increase the India allocation in their overall investment book.
All debt investors are encouraged to stay invested and continue to select funds in line with their individual investment horizon.
While there has been a concerted effort by the finance ministry and the Reserve Bank of India (RBI) to bring down inflation, the Consumer Price Index-based inflation and the inflationary expectations continued to be a challenge for policy makers. While there has been some softening in the Wholesale Price Index-based inflation, the food inflation remains high and is pushing overall inflation upwards.
Nevertheless, due to a sharp drop in the economic growth over several quarters and concerns due to drop in export growth and a widening CAD (current account deficit), the behaviour of the currency has been disappointing. Due to the decline in the value of currency along with slowing growth and widening CAD, the rating agencies have started to raise concerns over the quarters and pushed the sovereign rating outlook to negative.
RBI has stepped in with a rate-decline strategy, armed with low core inflation. Apparently, interest rates are poised for a steady decline over the months. RBI has started again with a 50 basis points decline in the repo rate over the last two months in two tranches, after a 50 basis points drop in April 2012. The yields of shorter maturity assets are expected to move lower over the months with the reduction in repo rates by RBI. The shape of the yield curve might turn steeper in case the yields of longer bonds stay at the current levels in the light of the huge borrowing programme of the government. In order to improve the growth environment and bring about the investment demand back into work the twin strategies of lower fiscal outlays accompanied by a benign rate environment is being pursued by the finance ministry and RBI jointly.
The possible steeping of the yield curve is expected to work in favour of all short-term funds and active income funds maintaining a low to moderate portfolio duration. The steeping of the yield curve, with decline in money market yields, are expected to work in favour of possible capital appreciation over the following two-three quarters.
Importantly, a well-managed borrowing programme of the government through interspersed OMO (open market operations) by RBI should also do well in keeping the sentiment buoyant for a stable to declining rate environment for long bonds as well. Hence, a stable upward sloping yield curve should support the borrowing requirement of both companies and government.
Additionally, the more recent market- friendly guidelines for foreign institutional investment (FII) in Indian corporate and sovereign debt are expected to improve the demand for Indian assets and increase the India allocation in their overall investment book.
All debt investors are encouraged to stay invested and continue to select funds in line with their individual investment horizon.
The author is head, fixed income, Religare Mutual Fund