The RBI may not tighten interest rates further if food inflation continues to moderate in the coming months, says Santosh Kamath, CIO — fixed income, Franklin Templeton Investments – India. In an interview with Ashley Coutinho, he says investors should look at corporate bond funds that can take advantage of high yields being offered on corporate securities. Excerpts:
Fund managers have been expecting interest rates to decline for quite some time now. How do you read the trajectory of interest rates for the rest of FY14?
A lot depends on the inflationary trends as well as external factors. Recent data has pointed to moderation in food inflation and if this continues in the coming months, RBI might not tighten further. Whilst the rupee has stabilized and the external situation appears to be comfortable, we remain cautious. Economic growth remains sluggish and there hasn’t been a meaningful decline in global commodity prices. Fiscal deficit projections are likely to be met, helped by special dividends, spectrum auction and divestment. On the other hand, India needs to address the structural issues with CAD (current account deficit) rather than trying to fund the deficit through temporary debt-boosting measures. Overall, we expect better visibility of interest rate direction in the coming months, depending on incoming data.
Recent data shows that wholesale inflation declined to a five-month low in December. Do you see inflationary pressures easing in the coming weeks?
While the high base effect might help with headline inflation data, concerns remain about food inflation. In an election year, dole-outs might end up in fiscal pressures and increased consumption that could be inflationary in nature. Hence, we need to look at the medium term trends rather than near-term data points. A lot depends on the global commodity prices and a slowdown in the Chinese economy could help.
Debt fund managers faced a tough time between July and September owing to the RBI’s unexpected actions. What’s your take as a fund house?
Actually, we had taken a contrarian approach compared to the industry. Notwithstanding the rate cuts earlier in 2013, we remained quite cautious about the environment due to our concerns about CAD and rupee. Based on our independent research, we were able to take a contrarian approach compared to the market as we were not comfortable with the macroeconomic parameters. We had positioned our portfolios not just for downside risk in growth but also currency, by keeping the maturities relatively low. This was in contrast to the industry trend that had focused only on monetary easing and went long to take advantage of potential capital appreciation. This helped us when RBI changed its stance to defend the rupee.
Do you see the rupee strengthening going forward?
Given India’s fundamentals, the probability of rupee weakening is higher. However, global capital flows along with India’s reform process will weigh. An uncertain mandate in the national elections can lead to weakening. FII inflows into debt markets have improved after the expiry of the swap window at the end of November. We will have to evaluate global investors’ allocations to EM bonds as rates start to move up in the US.
Which debt products will do well?
We believe that investors should look at corporate bond funds that can take advantage of the high yields being offered on corporate securities. In addition, those with a longer horizon of 1-2 years can look at long bond funds that can offer a combination of high yields as well as capital appreciation.
What is your advice to debt investors at this point in time?
For investors, our recommendation as always will be to choose funds based on risk appetite and investment horizon. Market timing is difficult and hence the focus needs to be on respective investment objectives, rather than short-term trends. Fixed income funds can provide potentially superior tax-adjusted returns compared to traditional income/savings vehicles.