The gradual easing rate cycle has spelt good news for fixed income investors in India. The benchmark ten-year G-Sec has seen its yield falling from 8.4 per cent in January 2012 to around 8.05 per cent by the end of December.
As far as the key interest rates in India are concerned, they have remained largely stable throughout the year, although the outlook tilted towards benign by year end. The Reserve Bank of India (RBI) cut repo rates by 50 basis points in April, changing the tone and direction of monetary policy to growth orientation. Thereafter, although there has been no repo rate cut due to inflationary pressures, the central banker statements, a series of cash reserve ratio cuts along with an statutory liquidity ratio cut and continued sombre growth data were all hinting at a dovish regime ahead.
Indian economic performance over the years has been influenced broadly by three broad systemic trends — the landed cost of crude oil, the aggregate agricultural output and the annual fiscal deficit. The interplay of these three factors determines the nature of inflation and the interest rates.
Our expectation is that the international crude oil prices might average around $110 (about Dh403) per barrel for most of the calendar year (provided no significant external shocks or unforeseen events occur). We also believe the volatility in the rupee may have bottomed out and a range-bound movement or mild appreciation may be in the offing for most of 2013.
Consequently, in the absence of any supply shock, the economy can expect the fuel-led inflation to moderate down on account of the high base effect in 2012. However, the structural demand pull may not allow the WPI-based inflation to go below the 6 per cent mark in the short to medium term. However, core inflation is expected to slide down even further.
This may give the RBI the necessary window in the early half of the year to likely reduce the repo rates by 50-100 bps from current levels. This change may provide an investment and consumption stimulus to the industrial sector, thus revving up the growth engines of the economy. The GDP growth is expected to range in the 6.8-7 per cent territory.
The debt market is increasingly basing its outlook at around the above view point. We believe the market may react positively to the rate cut; with a possible yield compression across the rate curve and the credit-rating band. The liquidity in the market, however, may continue to remain in the negative to prevent easy credit offtake. Moreover, the reduction in the interest rates and the on-setting reforms process may improve investor sentiments and also assist in sustaining India’s ratings outlook.
A caveat to this scenario may be the potential high fiscal expenditure on account of an expectation of early general elections. This might push up the real interest rates in the economy and further delay the much need recovery. However, the current initiatives on investments reforms and steps on subsidy rationalisation provide hope that the government may be able to balance its political and economic responsibilities.
In summation, we believe that the rate reduction cycle presents an attractive investment opportunity in the fixed income space. Investors maintaining an investment horizon of around one year could look at this category. Short duration funds that provide a flavour of duration management and accrual should also attract investors.
