Shriram Ramanathan
As we head into 2014, uncertainty still prevails – in the form of upcoming central elections, fiscal policies of the new government and structural food supply problems which lead to periodic high inflation. However, a couple of positives such as - attractive absolute level of yields, tapering being much less of an overhang, inflation possibly having seen its worst, a structurally lower CAD and hence a relatively more stable rupee do provide some support.
While the year could start off as a mixed bag of positives and negatives, we do believe that if a strong government were to get elected, and prudent policies are put in place – the market could see a sharp rally in the second half of the year.
Data dependency will be high, as has been repeatedly emphasised by the RBI governor. CPI Inflation is expected to moderate sharply, however the key is to watch whether it can drop significantly below the stubborn 9% levels seen in the past few years. Important in this regard would be the new government’s resolve to bring down inflation and implement effective supply side responses. The fiscal situation is a concern, and this is despite the government sticking to a fiscal target for FY 2013 and possibly for FY 2014 as well.
Over the next three years, a large number of government securities will mature, hence gross supply of government securities is likely to be very heavy. While the uncertainty on the government elections remains, we do expect policy to be well calibrated and forward looking, rather than reactive. The monetary policy framework is clearly changing. Increased emphasis on CPI (vs WPI), equal importance to headline inflation as given to core inflation, reduced usage of open market operations to manage yields and the need to generate a positive real return for savers are some of the important messages that have already become part of this new framework. Also, one can expect a buildup in forex reserves to be a theme over the next few years, and this will act as a guard against further rupee weakening episodes.
Investment strategy
From a fund selection and allocation perspective, we think risk – reward at the start of the year is in favour of lower duration funds such as short term and accrual oriented funds. While tactical rallies are likely given elevated yield levels, for a sustained secular drop in yields, we need to see clarity on policies post government formation. Hence, while the second half could witness a sharp rally in yields, we still believe it is better for investors to be prudent in their allocations – especially given that short end yields are fairly attractive, with much lower risk.
(The author of this article is Head – Fixed Income, at L&T Investment Management)
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