Rupee still overvalued relatively; short duration funds attractive: Manish Banthia of ICICI Pru MF

In a freewheeling chat with Moneycontrol, Manish Banthia, Deputy CIO, Fixed Income, ICICI Prudential AMC, said long-tenor bonds are not attractive at current levels and need to become cheaper to get into his portfolio. He also said that Rupee depreciation in line with broader basket of currencies will make the Indian currency more competitive. Edited excerpts:

The market had generally anticipated a 35 bps rate increase and therefore the RBI's policy was much in line with expectations. While certain market segments anticipated that RBI would signal a break or a change in stance, RBI was well-balanced in their approach and left it open-ended. They persisted in concentrating on inflation, which is still higher than their stated objective. From that stand point, it appears that the RBI is not done with raising interest rates and there may be one more rate hike going ahead

The one- to two-year portion of the curve, which is the shorter end, fairly prices an additional 25 basis point rate increase. Therefore, we believe that portion of the curve is fairly priced.

The long end of the curve, which is quite flat, is where we disagree. Market thinks that if the RBI is approaching the end of the rate-hiking cycle, the long end of the curve should be appealing as RBI will eventually cut interest rates. And in such situation, adding duration will allow you to profit from those trades.

However, I don't believe the RBI will cut interest rates in this part of the economic cycle. The RBI is now content with inflation hovering around 6 percent unlike previously where RBI’s monetary policy actions were focused on 4 percent inflation. With an additional 25 bps rate hike, at a repo rate of 6.5 percent and an average inflation of 6 percent, I don't believe that rates are restrictive enough to cause the economic slowdown. Infact, the economy will continue to expand with overall monetary policy being supportive of growth. In light of that, we believe RBI will not reduce rates any time soon and so adding duration through the long end of the curve may not be fruitful. The 10-year G-Sec at a yield of 7.25 percent looks expensive under the current circumstances.

7 percent used to be a desirable yield for a 10-year G-Sec when the RBI's inflation objective was 4 percent. However, with RBI's inflation target shifting to 6 percent now, the 10-year G-Sec would be attractive only at a yield of 8 percent or above. As a result, adding duration to the portfolio may not be logical at this point.

The broad range for the 10-year G-Sec under the current economic environment is 7-8 percent.

The market for fixed income moves in cycles. There will be times when interest rates increase or decrease. Because the base for previous year was low with repo at 4 percent and with RBI shifting interest rate to a neutral zone the yields have gone up which is reflecting in sub-par returns over the last one year. Because fixed income is a cyclical product, the better way to look at prospective returns is to look at prevailing YTMs which is in an attractive zone now.

Debt mutual funds are a better vehicle to invest efficiently given that investors can benefit from capital gains and indexation, unlike traditional fixed income options.

In the current environment, we prefer investments with a shorter duration as there is no additional yield available on the longer duration assets.

When we look at valuation across asset classes, fixed income appears to be better placed than equities given that valuation on the equity side is expensive.

Debt mutual funds are a better vehicle to invest efficiently given that investors can benefit from capital gains and indexation.

In the current fiscal year, the government’s tax collection has been much higher than expected which is likely to result in better fiscal number than what was budgeted. However, there have been some additional costs which the government had to bear. Therefore, the fiscal deficit expected for this current year would be around 6.15 and 6.20 percent which is lower than the budgeted number. Next year, the tax collection is expected to remain buoyant which should allow the government to consolidate the fiscal position further. While lower fiscal deficit will mean lower supply of bonds in the market, the pickup in private sector activity and credit growth should compensate for the room created by government’s lower borrowing. Therefore, the market impact will balance out.

Our existing risk framework is in-line with SEBI’s directive, so this is not a deterrent for fund outperformance. SEBI’s action is a step to protect investor interest.

Overall, we think that the government and the RBI have so far done a fantastic job where they have guided the economy out of the Covid period very well. The RBI policy particularly has been very supportive of growth throughout and the currency policy has also been largely driven by the objective of keeping it stable. However given that INR has depreciated less compared to the broader basket of currencies, in our assessment the Rupee has become overvalued and therefore depreciation in line with the broader basket of currencies will relatively make the Rupee more competitive.