I expect RBI to pause in June policy given CPI trajectory: Baroda BNP Paribas CIO Prashant Pimple

Prashant Pimple, Chief Investment Officer - Fixed Income of Baroda BNP Paribas Mutual Fund

After the unexpected pause in the April monetary policy, the Reserve Bank of India (RBI) is expected to continue pausing in the June policy too, considering the Consumer Price Index (CPI)-based inflation trajectory and risk of decelerating growth globally, said Prashant Pimple, Chief Investment Officer - Fixed Income of Baroda BNP Paribas Mutual Fund.

He further said the central bank would depend on the incoming data until the next policy and may wait and watch the inflation-growth dynamics, while keeping its guard up.

In March, India's headline retail inflation rate fell below the RBI’s upper-bound of 6 percent. As per government data, CPI-based inflation fell to 5.66 percent in March from 6.44 percent in February.

At 5.66 percent, the latest CPI inflation print is the lowest in 15 months, having come in at 5.66 percent in December 2021.

On the core inflation front, Pimple said they expect core inflation to soften as supply constraints have eased.  Thus, going forward, they expect input cost pressures to soften.

Pimple also spoke about the consequences of changes in debt fund taxation rules and the municipal bond market. Edited excerpts:

What are your views on the municipal corporations that are launching municipal bonds? Do you see demand for these picking up in this market?

Municipal bonds could be a good investment alternative for investment managers. However, demand for municipal bonds would depend on the credit health of those municipal corporations as well as the structure of the bond.

The Indian municipal bond market saw a push when SEBI’s Issue and Listing of Municipal Debt Securities Regulations, 2015 came into effect. The money raised helps municipal corporations fund new projects, and in turn, improve civic infrastructure. It also encourages them to become financially disciplined and governance-oriented. There is a thriving municipal bond market in India that has seen a three-fold rise in fund-raising since 2017.

In India, the municipal bonds market has limited depth compared to other debt instruments. Will the government’s push to municipal bonds deepen this market?

The depth of these municipal bonds would depend on the structure of the bonds, cash flow ring fencing, liquidity or acceptability of the bonds. These factors are important to increase the depth of these bonds compared to other debt instruments.

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What do you think of the recent changes in debt fund taxation rules? How will it affect the market and the mutual fund industry?

The recent changes in debt fund taxation rules brings debt mutual funds at par with other debt instruments like fixed deposits, bonds, etc. However, despite the loss of taxation advantage, debt mutual funds still offer liquidity to investors, mostly without any penalty, diversification - to minimise the risk from concentration, and also actively managed portfolio to enhance/optimise customer experience. Also, debt funds help in managing the interest rate risk with the mark-to-market function.

Another consequence of this development is that it is expected to make Hybrid funds more attractive where more than 35 percent of allocation is in equity and the advantage of LTCG tax of 20 percent exists with lower risk compared to equity funds.

Can you throw some light on your newly-launched floater fund?

A floating rate fund is like an all-season debt fund, where in a stable to rising interest rate scenario, the fund generates returns from floating rate instruments, and when rates fall, it gives returns by buying fixed rate bonds (FRBs) and using interest rate swaps. It is a fund that tends to perform reasonably well during both favourable and unfavourable economic and market conditions. Our expectations of interest rates staying high for an extended period ensures attractive YTM accruals. Also, we believe that higher accruals and lower supply of FRBs are likely to drive their future price performance.

The benefits of the fund are as follows:

•          Diversify across tenors to capture rate movements

•          Convert fixed to floater to implement tactical interest rate and spread views

•          Used to hedge portfolio in any interest rate scenario.

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The RBI has paused in the April monetary policy. Considering the domestic and global economic concerns, what do you think will be the central bank’s move in the next policy?

The pause by the RBI gives a signal that rates are near peak, if not at the peak. Both domestically and internationally, centrals bankers are expected to strike a balance between inflation and growth.

It is expected that the RBI would act depending on the incoming data until the next policy. We feel the next action could again be a pause, given the trajectory of CPI and risk of decelerating growth globally.

Also, MPC members in the April 23 policy minutes highlighted their assessment of growth to be shaped by the expectations of impact from external demand, spillovers from the banking crisis, etc., and expected lagged effects of the rate rise, which could play out in growth softening over the next few months.

Hence, we are of the view that the RBI’s approach will be to wait and watch the inflation-growth dynamics, while keeping its guard up.

Do you think the worst is over on the inflation front? Will it come down to the range predicted by the RBI?

Inflation is assumed to have peaked, arguably. Firstly, global food prices have declined sharply from their peaks. The Food and Agriculture Organisation’s (FAO) food price index, which measures five core global commodity prices, has declined by ~21 percent since March 2022. Other commodity prices like Brent have also moderated to $85/bl levels from the peak of around $120/bl levels in June 2022.

Further, we expect core inflation to soften as supply constraints have eased. Thus, going forward, we expect input cost pressures to soften. Also, the base remains favourable and could drive the headline number lower. We expect inflation to remain closer to the 5.00-5.50 percent band, which is within the RBI’s comfort zone. The upside risks to our projections can arise from an erratic monsoon leading to volatile food prices.