Know which fixed income funds will reap you good returns

Inflation continues to moderate.

The WPI based Inflation has been on a declining trend and stood at 4.70% for May-13. The Core Inflation, which is inflation in non-food manufactured products, eased to 2.43% in May-13. The demand-constraining effect of high interest rates on the core manufacting products is increasingly evident, albiet, the stickyiness in the CPI inflation remains a concern. Though in the backdrop of a normal monsoon, the CPI is also expected to temper down. This would provide RBI the needed headroom to effect a more robust policy response to boost growth in the coming months.

 

 

 

 

 

Currency Woes

The spurt in the international oil prices and the buoyant domestic demand for gold has seen the Indian imports bill swell faster than the exports could catch. Since Jan-10, Indian imports have grown by around 76%, almost in similar pace to that of the growth in the oil imports (in dollar terms). In the similar duration the exports growth has been around 57% (absolute). As a result the trade deficit has expanded at a rapid rate of 107% (absolute) over the last three years, and stood at around US$(-20 bn) in May 2013. This has caused pressure on the Rupee which has depreciated by around 18%(absolute) during the same period. This is expected to increase inflationary pressure due to higher landed cost in Rupee terms.

Moreover, the global strengthening of US dollar due to the anticipated drawdown in the QE3 (howsoever gradual), has seen the value of Rupee decline even further. As a result, more proactive policy measures have been required to draw in the forex inflows on the capital account (so as to stabilize the BOP).

 

 

 

 

 

 

It is worthy to mention here that the US Fed decision regarding the continuity, pace and quantum of the debt buy-back programme(QE3) in the upcoming FOMC meet (on 19th June) is gaining importance globally. It must be remembered that this debt buyback was aimed at keeping the risk premium in the US low; and keeping the banking liquidity afloat. This plan was devised so as to enable growth in the US e onomy by inducing credit offtake. However, the improving the economic situation of the US. With the US economy on the recovery mode, this programme (QE3) is expected to come under reevaluation. As a result, the US gsecs have hardened, raising the risk premium globally and strengthening the dollar. In turn, the FIIs have begun to pullout from the emerging markets to protect value. Thus currencies have declined even further against the dollar in the recent past.

We believe that RBI may have formulated this pause so as to obtain a full perspective on the evolving currency situation. The FOMC meet would be important in this regard so as to understand the future pace of the monetary action. The need to mitigate the imported inflation may have warranted this second look at the rate cut.

Having said that, WPI inflation remains on the downward trajectory and the good monsoon season is expected to drive it down even further. The languid pace of growth is still in the need a more robust monetary policy response. With Dollar-Rupee equation stabilizing, an additional 50-75 bps monetary policy action could still in the offing, albeit at a more gradual pace.

Investors, who seek to ride the declining interest rate curve and the compression in the yields; and have an investment horizon of 1 year or more, may look at the duration funds. Other investors can look at short duration funds that provide a mix of high carry of corporate bond with a flavor of long duration. 

- Lakshmi Iyer
The author is the Head of Fixed Income & Product, Kotak AMC