Yesterday, the Reserve Bank of India (RBI), in its annual monetary policy for 2012-13, slashed the policy rates by 50 basis points.
In an interview to CNBC-TV18, Chaitanya Pande, head-fixed income, ICICI Prudential MF and Shobhit Mehrotra, senior fund manager and head of credit, HDFC AMC, speak about the impact of the rate cut on bond yields.
Below is the edited transcript of the interview with CNBC-TV18's Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying videos.
Q: What did you takeaway from the policy? Do you see the yields softening further from this level of 8.31%
Pande: RBI has definitely surprised everybody with a 50 bps cut. Hardly anybody expected 50 bps. I think he has fired a good first salvo. Now where markets will go from here will be driven more by what the government does in terms of its fiscal deficit commitments. Given the fact that they haven’t raised petrol prices, the deficits already are looking a little unsustainable. I think 8.25-8.30% is sustainable for the moment. But the next move will have to come of what the government does.
Q: After the Budget, a lot of people were fearing that yields might go up all the way to 9%. Do you think those expectations need to be tempered, you have got a cap which is lower than that for the bond yield?
Mehrotra: Yes, definitely. I think 8.74% was the recent high, which we saw on 10-year government bond. To my mind, even reaching 8.74% looks difficult at this point of time. We have seen over the last few days that RBI has intervened in the bond markets. So that has helped cap the yields and that would also not allow 10-year bond yields to spike up. So, to my mind the range of 8.25% to 8.60% looks where the market should trade in.
Q: Do you concur with that or do you think that later part of the year if the market becomes tight once again because the governments borrowing programme, we might see this range shifting higher again?
Pande: For the moment, I think it will hold. As I mentioned the borrowing programme number without a petrol price hike looks like another Rs 56,000 crore extra borrowing may come. So, if we don’t see a petrol price hike soon, I guess this range could be busted slightly on the upside.
Q: What are you penciling in terms of the next three-four months in the June and July meetings? Do you think there will be any more good news for the bond market or you think it’s unlikely after what the RBI said and the range that you indicated will probably stretch through July-August?
Mehrotra: Yes, I think to expect further rate cuts in the first half look difficult. A lot depends on growth and inflation numbers which will come out over the next one-two months.
Unless and until growth really surprises on the downside and along with inflation also not rising, only then there would be some case for further rate cuts. But to my mind second half is when I would look for further rate cuts and may be at best 50 bps for the entire fiscal.
Q: What are you telling your investors to do right now? What kind of strategy having heard the RBI out, for short-term investors and for medium-term investors what strategy are you tailoring for them?
Mehrotra: On the longer end, we have seen a very significant move, 10-year bond having moved from 8.74% to close to 8.30%. So, a significant move has already happened on the longer end. While on the shorter end, we feel there is far more value.
We are at the beginning of the rate easing cycle. Once the yield curve, which is right now very flat, the corporate bond yield curve between 1-year to 10-year, it’s virtually inverted or very flat.
I think we are looking at a scenario where over the next few months we will see steepening of the yield curve that is the shorter end coming down quite a bit. This would help the short term bond funds. So, in my view, short-term bond funds are offering better risk reward at this point of time, while on the longer end we would advice caution because the big move has already happened. We would wait for the right opportunity may be once the yields back up again to the upper end of the range. That would be a good time to really look at long bond funds.
Q: For investors who have got into GILTs earlier and were feeling nervous about their investments, when they had spiked to 8.7% plus, do you think they should stay the course or would you recommend any adjustments for people who had moved to or added maturity to their portfolio a while back?
Pande: I think people who have got this move should possibly look to book some profits at this stage and come back you in again closer to 8.50-8.60% which is the upper end of the trading band. There will be opportunities as uncertainty is likely to continue in the long end.
Q: What about the shorter term funds?
Pande: The yield curve has already started steepening. This process will continue. Given our expectation that over the course of next one-two months government will take some consolidation measures, I think you could see another 25 bps at least or even 50 bps from RBI in the next three-five months.
Q: So, what would be in your order of preference the best products to be in now?
Pande: I agree with Mehrotra that short-term plans are probably the best in terms of a reasonable return with low volatility. You can probably look to enter duration or in piece of duration back again, if it goes up to 8.5-8.60% levels.
Q: For people who are in one-two year Fixed Maturity Plans (FMPs) what kind of returns should they be expecting, given what has been going on in the dynamics of the money market?
Mehrotra: From the peak of close to 11%, on the one year bank Certificates of Deposit (CDs), we are down today to close to 9.70% on the one-year bank CDs. So, we have seen a very decent move. It lot depends now over the course of the year, if the rate cuts are likely to continue then even these levels are pretty good to consider investing in one-year fixed maturity plans. So, to my mind shorter end still has some more room to come down and may be over the next three-six months we could see one-year bank CDs trading between 9.25-9.5%.
Q: What would be the relative picture as we go deeper into the year between deposit rates? Deposit rates will probably begin to inch down and the returns that investors could get from short term funds, I am not talking about the tax aspect which are obviously more favorable for you, but on pure return, how would they compare in a declining deposit rate scenario?
Pande: See short-term funds obviously have an added advantage that in addition to whatever carry portfolio yield there is. There is also potential for capital gains. So that I think is what is the key advantage here that a) they are open ended fund and b) there is a potential for capital gains as rates come off and the yield curve steepens over the course of the next 9-12 months. So that’s the key here.
Q: In a relative world, how would investors be between fixed income products, mutual funds and declining deposit rates?
Mehrotra: I always feel that the flexibility offered by open ended product has to be valued. Short-term bond funds without offering too much of volatility provides you flexibility as well as good returns. So, they need to be getting decent allocation in investors portfolio. While I don’t think the allocation to short-term bond funds or to debt funds in general with the investors is adequate enough. There is enough room for them to add on to open ended short duration debt products.