Fixed income attractive again

The recently held Reserve Bank of India (RBI)’s monetary policy delivered a sharp surprise to the fixed income market, not only by maintaining a status quo on rates (while the market expected at least a 25 basis points cut from 6.25 per cent), but also by changing its two-year stance of being ‘accommodative’ to ‘neutral’, potentially implying the end of the current easing cycle.
 
The market reaction to the same was sharp, as it had considered rate cut a given, especially after demonetisation. However, the initial indication of the current RBI stance was visible when the central bank chose to hike the required cash reserve ratio in November 2016 policy. It clearly sent an early signal that there was disconnect between what the market was expecting and the RBI.
 
In the current setting, we are of the view that the latest action of policymakers has turned the market sentiment bearish with respect to fixed income, thus providing an investment opportunity for medium-term investors. The market, which before the policy was in a late cycle (symbolic of an overheated situation), has now got pushed to the mid cycle (akin to moderate growth phase), making fixed income a relatively safer asset class again. Hence, we believe this can be the time to invest in fixed income.
 
This view is mainly because of the lack of any stimulation to the economy via the three tools, which can be generally used — 1) interest rates, 2) fiscal policy and 3) currency.
 
After demonetisation, the economy at the margin has slowed down. As far as monetary policy is concerned, it has tightened the monetary conditions rather than stimulating it. Even the currency has appreciated, which means tightening for export-oriented sectors.
 
 Also, we saw fiscal deficit to be lower than last year, indicative of fiscal policy not being expansionary with only six per cent increase in the expenditure budget. Because of the change in tax advantage structure which real estate had, coupled with the effects of demonetisation, the demand for real estate as an asset class may remain low, especially from the retail segment.
 
This indicates low credit growth from retail along with an already slow corporate credit growth. RBI has acted as a risk manager by targeting lower inflation, making fixed income attractive again, for investment.
 
With the current upmove in yields, valuations in fixed income have turned attractive. Had the policymakers decided to stimulate the economy by increasing fiscal deficit or by reducing interest rates, it would potentially mean close to an end of this rate cut cycle.
 
The current stance of policymaker points to opportunities available for investing in short- and medium-duration funds, as they look poised to offer better risk-adjusted returns.

The author is ED & CIO, ICICI Prudential Mutual Fund