Indian bonds unlikely to attract incremental flows: SBI MF's Radhakrishnan

While the RBI's overall policy intent is clearly growth supportive, the shift to neutral stance has been a communication challenge, Radhakrishnan said

Despite the Reserve Bank of India's (RBI) bumper 50-basis points (bps) rate cut, long-term bond yields have risen, limiting the impact of policy easing. Rajeev Radhakrishnan, chief investment officer for fixed income at SBI Mutual Fund, tells Devanshu Singla in an email interview that investors entering at this stage of the (interest rate) cycle should moderate return expectations. Edited Excerpts:

  How do you interpret the RBI’s recent monetary policy statement?

  RBI’s policy actions have clearly been targeted at ensuring transmission of policy cuts into bank lending rates. While the overall policy intent is clearly growth supportive, the shift to neutral stance has been a communication challenge. The overall impact has been a softening in the money market segment, while other short-end rates have stayed broadly the same after an initial rally and there has been some hardening in long term market yields. This is thereby likely to dilute some of the transmission that has already happened and could further happen in the bond markets after such a large policy easing.

 

How are you re-thinking your duration and credit strategies post-policy?

 

We do not consider that there is any risk of any immediate reversal in RBI’s liquidity or rates policy with a neutral stance. While the base case remains of a pause in the next couple of policy meetings, further softening of headline Consumer Price Index (CPI) estimates in a below potential growth environment could possibly open up a marginal additional space for cuts.

 

Even as a base case, with surplus liquidity, the effective rates should stay at the lower end of the Liquidity Adjustment Facility (LAF) corridor rather than at the policy rate.

  On an incremental basis, accrual remains the priority while we still expect some modest easing in long-term rates from current levels. Duration and credit strategies would be calibrated in this context in individual portfolios considering the portfolio risk mandates.

 

  Do you see value in duration strategies, or is the short end still the preferred space for investors?

 

A steep yield curve would sustain as liquidity surplus continues in the foreseeable future. This should also lead to spread tightening, more so at the shorter end. On an incremental basis, short end, 3-5 year high grade bond products would possibly be relatively attractive from a risk reward perspective over duration strategies.

 

With India's inclusion in the JP Morgan EM bond index now active, what kind of foreign participation are you witnessing or expecting - particularly in long-term Government Securities?

 

While India macros remain relatively better on a cross-country basis, Indian bonds are unlikely to attract incremental flows in the coming year. Elevated developed market yields and possible bottoming out of the policy easing cycle in India would be factors that could hinder FPI flows. Investors would also continue to factor in some modest currency depreciation, even as we believe that on an inflation differential basis, the impact on currency markets should be modest going forward.

 

What risks should investors be mindful of in the current rate-cycle, especially those entering the debt funds at this stage?

 

Investors entering at this stage of the (interest rate) cycle should clearly moderate return expectations. It must be appreciated that even though policy rates were cut by 100 basis points, 10-year bond yields had already fallen by about 120 basis points over the 18 months before the latest policy action. Even as there remains no immediate risk of a cycle reversal at this stage, one must acknowledge modest prospective returns broadly in line with accrual as a base case.