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Last Updated : Jun 08, 2017 10:44 AM IST | Source:

Domestic, global macro factors warrant benign interest rate scenarios

We believe that duration funds have reasonable growth potential in the current market trend.

Lakshmi Iyer

The latest monetary policy was largely on anticipated lines. While the major macro-economic variables have largely turned favourable, the impending GST impact and the latest geo-political gyrations were still reasons enough to be circumspect.

Having said that, the RBI is increasingly aware of the downward trend in the CPI inflation. The 2.99 percent CPI inflation for Apr-17 is not just the outcome of the base effect but of the rising supply in the pulses and vegetables that have pulled down the prices. The Core inflation too has showed a downward decline in April. Resultantly, the RBI has revised its inflation projection downwards for FY18. This is a positive shift by the central banker.


As we foresee it, the CPI inflation for most part may be below the 3 percent level during the H1-FY18 half. At that, even in H2-FY18, when the CPI is expected to rise, yet the inflation even during that phase is likely to remain well below the RBI’s forecast level.

In our view, the announcement of the GST rate bands also has helped address many of the inflationary concerns. Our estimates suggest that, the Government, in line with its guidance, has succeeded largely in keeping the changes in tax rates inflation neutral from a Consumer Price Index (CPI) standpoint.


Globally, the US 10 treasury yields have priced in the June rate hike. There is an emerging view that the US Fed may approach the future rate hikes more gradually going forward. This has created a positive outlook on the Indian Rupee as well

The Indian Rupee has emerged one of the strongest performing currencies in the recent past. This has created an ample liquidity overhang as well as provided the stimuli for the FIIs to re-enter the Indian debt market. FIIs have pumped in around $14 bn CY 2017 YTD (year to date) investment in Indian debt market. In fact the buoyancy of Rupee poses an additional factor for FIIs to view India debt favourably over and above the current carry yield available

From our view point, the interest rate scenario continues to remain benign. Especially with the revised CPI forecast. In fact, even at 5 percent CPI, the current yield curve provides reasonable real interest rate return. We believe that the declining inflation outlook, high real interest rates and low credit off-take may warrant a rate cut sooner than later. In our estimate, the RBI has a room for a benchmark repo rate cut of 25 at least bps.

With that scenario in mind, we believe that duration funds have reasonable growth potential in the current market trend. Additionally, the spreads between the 10yr and 25-30 year gilt are trading much above the long term average. Thus, even the spread compression (which has only just begun) is likely to generate alpha for the investor.

For investors seeking a more stable bias on one’s portfolio, corporate bond based accrual strategies could be considered. Tail end allocations to actively managed duration funds could be a viable option during market consolidations. We suggest existing investors in duration funds to stay put.

Bottom-line, global as also domestic macro factors warrant stable/ benign interest rate scenarios. Investors could look at the suite of fixed income offerings to potentially benefit from India rates story. It’s time for investors to participate meaningfully in 'Acche Din' in fixed income investing.

Author is CIO (Debt) & Head – Products, Kotak Mutual Fund

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First Published on Jun 8, 2017 10:44 am
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