Near-term opportunities in bond market

Kunal ShahKotak Life Insurance

Indian economy is at an inflection point, new government in power can easily pick low hanging fruits by making structural changes in policy making and correcting the bad-mix of redistribution of resources to productivity enhancing measures, and it will benefit growth and inflation in long run. As structural decisions are made, outlook on financial markets can improve drastically as we have seen recently in stock prices.

For interest rates, positive news was inflation targeting initiative by RBI. If government agrees with the central bank it will bring in benefits of transparency and accountability to monetary policy setting. Inflation targeting will also appeal foreign investors as real rates have been negative for a while.

However as it is apparent that inflation problem in past five years has been more on food & services which can corrected solely by fiscal policies rather than just interest rates. New government will be required to take stern measures on issues like subsidies and rural wages. High real wage growth will make more sense than having 16% nominal rural wage growth with double digit inflation.

For bond markets it will be time of patience as structural corrections in policy mix can be painful in short-term but comes with larger long term benefits. For example, to bring down inflation to 6% in next two years will require tighter policy absence any tactical easing to revive growth. However if inflation does indeed drops to 6% it will create ample space for easing rates and such easing by RBI will be more durable and long-term.

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Kunal Shah

Fund Manager- Debt|Kotak Life Insurance

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  Bond yields should trade in 7.70-8.1% range till September
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  If MSP hike impacts inflation materially, we could see another 25 bps hike by RBI
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  Expect 10-year bond yield to trade in the range of 7.00-7.30% : Kotak Life

Hence it does create opportunity for long-term investors to invest in fixed-income products, as the  best times to invest in rates sensitive assets is when markets aren’t expecting any easing in near-term. Bond yields are close to 9% today, if fiscal consolidation continues and RBI sticks to inflation fighting bonds can deliver very good returns in next couple of years. It is not very difficult to imagine how much RBI will ease if indeed CPI drops to 6% (by 2016) from current mix of Repo rate 8% and CPI 8.5%. Having said that ball is in the court of government now to make right choices to sacrifice short-term optical benefits and work with RBI for long-run & durable benefits. Such policies are ideal and will enhance trend growth rate back to 8%.       

Following can be the list of instruments where investors can get take exposure to rate sensitive assets:1. Long term bond funds – funds with exposures to long-term government securities.2. Dynamic bond funds – where duration is adjusted as per the view on interest rates.3. Tax Free Bonds – Public sector 10-15y tax-free bonds.4. 10y G-Sec Futures.