Negative surprise on fiscal deficit unlikely in Budget: Nippon India MF CIO

The current government, right from 2014, has shown an inclination to maintain fiscal discipline, he says

The Reserve Bank of India (RBI) is expected to announce two 25 basis points (bps) rate cuts in the current financial year (FY25), according to Amit Tripathi, CIO – Fixed Income Investments, Nippon India Mutual Fund. In an interview with Abhishek Kumar, Tripathi says the central bank may ease the rates further in the next financial year. Edited Excerpts:

How do you see the debt market dynamics and is there any visibility on rate cuts?
 

The longer end of the debt markets (10 years and beyond) has meaningfully benefitted in the last 24 months owing to the secular reduction in twin (fiscal and current account) deficits and the impact on core inflation. The shorter end (1- 5 years) has remained largely range-bound.

However, as the global macro headwinds and currency pressures have abated and inflation has been anchored at a lower level of 4.5 per cent, the RBI is comfortable providing adequate liquidity into the system. This has led to 25 bps de-facto easing in overnight rate settings since the start of 2024.

We expect at least two 25 bps policy rate cuts in the ongoing financial year, followed by some easing in the next financial year, especially if global and local growth conditions start tapering off. We expect the RBI to allow better liquidity conditions to prevail in the ensuing quarters.

What are your expectations from the Budget? Is it driving any changes in scheme portfolios?
 

The current government, right from 2014, has shown an inclination to maintain fiscal discipline. Given the current tax buoyancy and the larger RBI dividend, we would not expect any negative surprise on the 5.1 per cent fiscal deficit target for FY25. It could potentially be lower if the government decides to step back given that the broader economy is doing well. Our portfolio positioning remains aligned to benefit from a downward shift in rates.

Budget or otherwise, what are the possible headwinds or risks that worry you?

The post-Covid world is characterised by ‘fiscal dominance’. The sharp increase in sovereign indebtedness creates fragility in the global financial system. Further, the two largest economies are struggling with different sets of problems. While China is dealing with overcapacity and strains in the property sector, the US continues to face the fallout from the post-Covid fiscal excesses. This has possible implications in the form of higher than pre-Covid terminal policy rates, which then have global implications across rates and currencies.

Closer home, the K-shaped recovery will possibly drive specific policy actions, including in the upcoming Budget. Any action, that leads to large changes in fiscal focus (revenue vs capex), or a postponement of the fiscal consolidation path, will have a negative fallout on the debt markets.

Your dynamic bond fund portfolio has nearly 90 per cent exposure to state development loans (SDLs). What makes you bullish on SDLs vis-a-vis central government bonds (g-sec)?
 

Our dynamic bond fund is currently running a moderate duration strategy and a sovereign portfolio composition predominantly through SDLs. The intermediate duration positioning will help it deliver reasonable returns in case the curve steepens and moves lower in the next 12-24 months in line with our expectations. The higher allocation to SDLs within the sovereign category helps improve the overall carry of the portfolio and adds to total returns when spreads between g-sec and SDLs tighten.

What is your take on longer-tenure government bonds? Is there scope for further gains?
 

For the performance to continue in the next 12-18 months (in yield terms), the global and local growth forecasts have to move lower meaningfully, which then could lead the markets to factor in a lower terminal rate in the ensuing rate cycle (lower than 5.75-6 per cent). Longer-term investors should prefer government bonds to avoid the reinvestment risk.

MFs have raised exposure to AA and below-rated papers in recent months. What is leading to higher interest?

The significant deleveraging across the corporate and financial sectors pre- and post-Covid has reduced balance sheet vulnerabilities to adverse demand and price cycles. As such, there is merit in investing into some of these issuers, where the present and future credit quality is on an improving trend. However, such investments have to be backed by quality research. Investors with a suitable risk appetite should add exposure to credit risk funds.