RBI may hold rates, but 50-75 bps hike still in sight: Nippon India MF CIO

Nippon India MF expects the RBI to keep rates unchanged for now, while forecasting a limited 50-75 bps rate hike cycle over the next 12-15 months

Government security (Gsec) yields may remain range-bound in the near term as markets have largely priced in a limited rate hike cycle, according to Amit Tripathi, president and chief investment officer – fixed income at Nippon India Mutual Fund. In an email interview with Abhishek Kumar, Tripathi says that select segments of the bond market — particularly 2-5-year corporate bonds and 25-40-year Gsecs — continue to offer attractive risk-return opportunities. Edited excerpts: 

Gsec yields have eased from their highs but remain elevated. What factors are keeping yields high? 

Gsec yields are lower than their May-June highs. The Foreign Currency Non-Resident (Bank), or FCNR (B), deposit announcement has removed the tail risk from a balance of payments and currency standpoint, and, therefore, from the Reserve Bank of India's (RBI's) reaction function perspective.

 

However, a combination of higher headline inflation, a widening combined fiscal deficit, and an elevated trade deficit has kept rate hike expectations alive, albeit for a slow and limited rate hike cycle. The rise in global yields and yield curve steepening have also contributed to the pressure on domestic yields.

 

Having said that, on balance, yields are reasonably well behaved in the context of continued global macroeconomic uncertainty.

 

What are your expectations from the ongoing monetary policy committee (MPC) meeting? 

We expect the RBI to remain on hold at the ongoing policy meeting, though we continue to expect a limited rate hike cycle of 50-75 basis points (bps) over the next 12-15 months. We also expect the central bank to reiterate the heightened uncertainties in the domestic and global environment, along with its intent and preparedness to address these challenges through appropriate policy measures. Finally, we expect the RBI to continue its current approach of providing adequate liquidity to ensure smooth functioning of financial markets and the banking system.

 

Are yields attractive at current levels? 

The yield curve is appropriately valued for the most part, as the market has broadly priced in these rate hike expectations. We expect yields to move within a narrow range of 10-15 bps in the near term.

 

However, in the context of FCNR (B) flows, a limited rate hike cycle and low and stable core inflation, 2-5-year corporate bonds, as well as longer-tenor Gsecs (25-40-year maturity) are attractively priced. While we do not expect yields to decline sharply from here, these select segments offer attractive risk-return tradeoffs.

 

What are the key risks? 

The risks are broadly well known and mostly macroeconomic in nature. While FCNR (B) reduces the tail risk for now, it is only a temporary replacement for long-term stable foreign direct investment (FDI) and foreign portfolio investment (FPI) flows, which need to pick up soon. The overall current account deficit (CAD) remains under control, but the market would need comfort around the balance of payments beyond the FCNR (B) measure.

 

Second, the scope for further fiscal consolidation remains limited, and there is a risk of slippages and/or deterioration in the quality of public finances, especially at the state level. Third, we seem to be in a better place with regard to nominal growth and core inflation dynamics, but we cannot afford any slipups in the near to medium term. There is limited room for policy errors.

 

Is it the right time to raise duration? 

The argument on duration is slightly nuanced. The 5-15-year part of the curve is reasonably priced but not especially attractive. We like the longer end of the yield curve (25-40-year Gsecs). At annualised yields of over 7.5 per cent, they provide a significant cushion over expected headline and core inflation in the medium to long term. The demand-supply dynamics in this segment are also supportive, with the government reducing supply, although states continue to extend the maturity profile of their issuances.

 

We believe these long-duration bonds should form an integral part of investor allocations, albeit with a clearly defined long-term investment horizon.

 

What is your view on lower-rated papers? 

We do not view credit purely in terms of ratings, but rather in the context of the expected improvement or deterioration in credit quality going forward. Unlike the past three to four years, the risk of macroeconomic uncertainties feeding into business risks has increased in recent months. While corporate balance sheets remain healthy, leverage is low, and management quality is generally strong across the board, lower-rated assets should always be evaluated carefully before taking exposure. We recommend investors do that groundwork themselves or rely on professional advice or fund management.

 

How are your fund portfolios positioned currently? Has there been a change in strategy in recent months? 

The duration profile of most of our funds remains neutral, with a focus on carry. Our allocations outside the liquid and money market categories are predominantly in 2-5-year corporate bonds. The credit profile of these bonds is determined by the respective scheme mandate and the relative value of taking incremental credit risk.

 

However, select funds with the mandate to invest in 25-40-year Gsecs, such as the Gilt Fund and Long Duration Fund, have meaningful allocations to this segment. Given the heightened volatility in recent months, we have also used interest rate swaps more actively, both as a hedge and to capture some of these market movements.

 

The RBI and the government have announced several measures to attract foreign currency inflows. Do you think these are enough to offset external risks and provide sustained support to the bond market? 

The decision to remove withholding tax is welcome, as it makes the regime simpler for overseas investors. We have already seen a limited positive impact from that.

 

The FCNR (B) announcement removes the tail risk of extreme currency movements and the risk of an aggressive RBI response on interest rates, thereby helping stabilise markets. Having said that, our ability to attract long-term and stable capital flows in a highly competitive, volatile, and polarised global environment remains a key monitorable.

 

FCNR (B) is a short-term stabilisation measure and not a long-term permanent solution. We remain confident that more policy measures aimed at improving the ease of doing business and attracting foreign capital will be introduced over the next few quarters, providing a fillip to long-term inflows.

 

From a bond market perspective, beyond these measures, it is equally important to create a level-playing field for domestic investors from a taxation standpoint. Debt is the only asset class that does not provide incentives for long-term allocations. This not only skews investment flows but also creates a lopsided risk profile for individual investors, leading to broader market mispricing across asset classes. It has also constrained the growth of debt capital markets, limiting their contribution to asset creation and economic growth.