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Last Updated : May 16, 2013 02:18 PM IST | Source: CNBC-TV18

Here's how experts see bond markets reacting to RBI easing

"We are looking at between 7-7.25 percent in the 10-year bond pretty soon," Ananth Narayan of StanChart Bank says.

In an interview to CNBC-TV18, Ananth Narayan, Co-Head of Wholesale Bank, South Asia, Standard Chartered Bank and Rahul Goswami, Head - Fixed Income, ICICI Prudential MF spoke about their reading of the bond market and their outlook.

Also read: Indian rupee largely steady in early trade

Below is an edited transcript of the discussion on CNBC-TV18.

Q: It has been a complete collapse to 7.36 percent, which was the intraday low on the yield yesterday. Since it has bounced back a bit do you see levels falling even more or have most of the rate expectations being captured in this slide?

Narayan: I think the rate fall continues. We could see some blips here and there. In fact, the new 10-year bond, which was due to be auctioned this week, is already dealing at about 7.25 percent or so. We are looking at a lower set of rates and the inflation prints of the recent past obviously help. All in all, there is scope for rate cuts, open market operations (OMO) to continue because of liquidity tightness. We are looking at between 7-7.25 percent in the 10-year bond pretty soon.

Q: Which kind of products is it helping the most because generally fixed income investors have done well whether they are in gilt or they are in short-term income funds? Where have you seen most of the recent gains getting captured?

Goswami: Most of the gains have come in the long duration funds like income funds and the gilt funds. The shorter and the medium-term maturity funds have also done well. But structurally we see the rate down move will continue for some more time, at least through this current financial year.

I agree with what Ananth has said. Basically around 7 percent looks reasonably achievable and one will continue to see some volatility and some pullbacks here and there. But structural down move in rates is there to continue because of inflation (easing) and we expect softness in commodities also. That will also be supportive.

The Reserve Bank of India (RBI) will have more flexibility and space as far as monetary easing is concerned.

Q: Could you just put into perspective what kind of gains there has been so far though for someone for exposure to G-Secs as also what your own tactical call is right now – are you guys saying it is a good idea to stay long or do you think the bulk of the rally for the bond market is out?

Narayan: It has been quite a move actually. Since the beginning of the year we started the 10-year bond at about 8.05 percent. So, clearly it has been a sharp move from there over 60 basis points at the current moment and looks like continuing further.

Tactically, we continue to remain long. There are chances of pullbacks and one must remember that because it has been at a sharp move. Like Rahul was mentioning a while back there will be the odd pullback which happens. One thing which has held back a dramatic rally has been the apparent reluctance of RBI to cut rates further from here as they have mentioned in every policy. That I think will ease going forward, given the drop in inflation below 5 percent and core inflation below 3 percent. Clearly, the pricing power amongst producer has just come down because of this slow down in growth. That should give some room to the RBI to cut rates further.

The other problem of current account deficit which RBI flagged off the last policy as a huge concern still remains. April data was disappointing on the trade front. However, frankly, we are hopeful that shouldn’t be so much of a problem continuing going forward. We see exports improving from here. We see demand for gold coming down from here. Anecdotal flows on the capital side remain pretty high both on foreign direct investment (FDI) as well on the foreign institutional investor (FII) front. All in all, forex will remain under control as well. Inflation already showing signs of being under control and we therefore see room for RBI to cut a bit more on rate. So, in the June policy we are expecting a 25 basis points rate cut

Q: What is the best instrument to approach this year because now there is also going to be inflation indexed bonds. The first tranche comes in as early as June. What would you pick for FY14?

Goswami: We remain quite bullish and positive on the rates front so instead of inflation indexed bonds I would prefer to buy 10-year or high maturity papers against inflation indexed bonds. However, having said that, for a floating date instrument I definitely think inflation indexed bond will generate demand. There will be demand subject to the pricing of the bond remains reasonably rich for investor because it will also attract some amount of liquidity in the instrument.

It will not remain as liquid as the benchmark 10-year or 12-year or 5-year paper. As long as those pricing is reasonably rich there will be reasonable demand in inflation indexed bond and with inflation coming down so if one’s real rates are high on inflation indexed bonds then the demand will definitely be there.


Q: Can you give us some indicative numbers on what kind of gains have been clocked by a range of fixed income products if you annualize performance in GILT Funds versus medium-term funds, what kind of ballpark return are we talking about just so that people can compare it with fixed deposit?

Goswami: Last one year income fund would have generated returns in the range of 15-17 percent and GILT funds again basically would have generated return in the range of 16-18 percent on an annualized.

It may not be fair to assume that next year again we will be able to have the same amount of return, but definitely in the short-term and the medium-term funds, which typically runs with 3-year to 4-year average maturity. That is roughly around 13-14 percent return basically 13 percent return plus/minus 50 bps depending on the fund maturities and how the fund has been structured.

Going forward, we definitely want to tone down the expectations and last year we saw rates were also reasonably high as compared to what it is today. So, though we think that higher maturity funds (HTM) in next one year will continue to outdo the money market funds or basically to protect their investment risks from further downward revision in the interest rates. So, our base pick is basically 3-5 years maturity bucket which typically remains quite rich.

Going forward, we expect the Central Bank to do more open market operations (OMO) and buy bonds in the shorter-end of the bucket rather than infusing liquidity they end up buying 10-12 year maturity bonds. So, basically we believe that higher supply at the longer end and if Central Bank decides to do OMO at the shorter end of the curve. We believe shorter end of the curve is quite rich and should be reasonably well rewarding.

Q: What does it mean for deposit mobilization for banks? If deposit rates come down in line with lower interest rates in the general economy, do you think banks will still struggle to get deposit mobilization even as on the face of it real interest rates are going up now?

Narayan: It is a very good point that you have brought out. The dilemma remains the lack of liquidity in the money markets. So, even today the optical short fall in the overnight market is about Rs 1,30,000 crore. The core shortfall itself has gone up to about Rs 75,000 crore.

Clearly there is a lot of currency leakage is happening in the system. That trend seems to continue. As it is coming close to an election year, that trend will probably continue further.

So, banks do have this dilemma that while structurally rates are moving down and the Reserve Bank of India (RBI) has been cutting rates, liquidity remains enormously tight. That will remain a challenge.

The good news of course is that the CD rates have come down as well. It is about 8.2 percent right now for one year CDs. However, I think banks will struggle to have deposit growth come through given the liquidity challenges.

I think one ask that we have of RBI is keeping the liquidity channels available particularly for the productive sectors like infrastructure maybe having a window where we can borrow or refinance against infrastructure loans. That is definitely offering at the moment given the lack of liquidity.

Q: The move on the rupee has been quite worrying. Is it an Asian region or a rupee problem? What kind of levels are you guys expecting to see?

Narayan: To be honest, the dollar has been strengthening quite a bit over the last few days. Euro at 1.2850, dollar-yen at above 102, so it has been a dollar rally throughout.

The trade data for April was a disappointment. We were hoping for a lower number than USD 17.8 billion. The amount of gold import continues to be a worry.

Going forward, I think the news is reasonably positive for rupee. One of course on the capital flow front, the news remains positive. Anecdotally we are talking about the Hindustan Unilever Ltd (HUL) and Bharti Airtel money coming in. Also more of foreign direct investment (FDI) coming in. Foreign institutional investors (FIIs) room is available right now, that withholding tax removal was a huge positive. Especially if we are bullish on the fixed income markets, we expect money to trickle in on the FII front.

Even on the trade data front, I think data will improve going forward. Export should do better with private sector. The US doing better and commodity prices are behaving themselves. Gold is below USD 1,400 per ounce again and that is good news for us.

So, all in all expect the overall balance of payments for the dollar rupee to be positive for us. Rupee can head towards closer to 53.50 by the end of this year. It remains in a range of 53-56. This is probably the top end of the range right now, so expect a move down to 53.50. The joker in the pack of course is politics and coming closer to the election date.

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First Published on May 16, 2013 11:19 am
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