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BW Businessworld

Testing Times

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High inflation and ballooning fiscal deficit has been the concern for Chaitanya Pande, head of fixed income at ICICI Prudential Asset Management Company, who feels the government in the coming weeks before the Reserve Bank of India's (RBI's) monetary policy will bite the bullet and increase fuel prices. He sees RBI's decision will follow government decision and therefore RBI will cut rates (repo rates) by 25 basis points (bps) on 17 April 2012 and in total 75 bps by the end of the year.

Talking to Businessworld, he feels the only way government can achieve its targets (fiscal deficit) would be to bring down the subsidies and pass the burden in form of hikes to the consumers, otherwise it becomes difficult for the government to manage its finances. The fixed income manager sees the 10-year government securities (G-Sec) yields to be volatile for the next 3-6 months because the supply is significantly larger than the market has seen. In the absence of policy measures, he expects 10 year G-Sec to rise to 8.75 per cent, while policy measures that will trigger fiscal consolidation have the potential to bring the G-Sec down to 8.00-8.25 per cent.

Talking about investment in fixed income, he feels anytime is a good time to invest, but retail investors should come through mutual funds as the fixed income market unlike equity market is a big boys' market. Though short in supply, he currently prefers investing in 1-3 years corporate bonds. He also suggests that investors should park their money in 3-year fixed maturity plans (FMP) and regular saving plans. Meanwhile, his own investments is skewed towards debt which is around 60-65 per cent of his portfolio, followed by equity which is around 30-35 per cent and the rest 5 per cent in gold. However, he is waiting for a correction in gold to increase his exposure to the yellow metal to 10 per cent.

Excerpts from the conversation:

Despite rate cuts why is the market still struggling for liquidity? What is your assessment of the Indian economy? 
The tightness in liquidity in the short term is due to the fact that the expected government spending is yet to happen.  The government surplus of around Rs 1,20,000 crore is currently with the RBI and is expected to be spent over the coming week. Additionally there are some maturities expected in the first half of the week. With the combination of expected government spending and maturities on the anvil, we expect the liquidity scenario over the next week to be easy and also possibly +/- 1 % within RBI's band over the next month.

We therefore expect liquidity in the first quarter of FY13 to be relatively easier since there are a lot of maturities coming up and also RBI is expected to begin its rate cut cycle. The second quarter will show some strain since RBI is unlikely to do too many open market operations (OMOs) in the first 2 quarters of FY13.

Do you expect RBI to cut rate cut in the forthcoming monetary policy on 17 April 2012 and why? If yes, then by how much? If no then when do you think RBI will start cutting rates?
RBI has a stated objective in moderating growth and fiscal consolidation to initiate rate action. Also there is usually a 6-12 month time lag between RBI's rate cuts and its effects filtering to the economy. Hence even if he cuts rates now, it will start reflecting in the economy only in the second half of the year. We expect RBI to cut rates in April policy by around 25 bps, albeit only if the government is able to pass through the oil price hikes. In case the government is not able to pass through oil price hikes, the viability of fiscal consolidation gets called into question and cuts might get pushed out till further clarity is achieved.

What is your take on the 10-year G-Sec yields and why?
The 10-year government securities (G-Sec) yields will definitely be volatile for the next 3-6 months because the supply is significantly larger than the market has seen. There is to some extent supply fatigue in the market. At the same time there are some potential positives.  If the government were to actually bite the bullet and pass on the oil price hikes, we expect the RBI to initiate a more sustained cutting cycle. Hence it is a combination of push and pull factors i.e. pull by the weight of the supply and push by fiscal/monetary policy action either by the government or RBI that will drive G Sec yields. In the absence of policy measures we expect 10-year G-Secs to trade in the range of 8.50 – 8.75 per cent. On the other hand, policy measures that will trigger fiscal consolidation have the potential to bring it down to around the 8.00 - 8.25 per cent.

As a fund manager how are you managing the money in your portfolio and where are you investing in this market? In current market condition where will you advice investors to invest?
All our investment decisions are aligned to the mandate of the fund. Hence in the short term funds we buy predominantly short-term papers. In the longer duration, funds we are adding duration, albeit cautiously, given the current uncertainty on policy actions and the viability of fiscal deficit target.

Meanwhile, we have always held the view that there is no one-solution-fits-all for investors and deciding on funds to be invested in would depend on investment horizon and risk appetite of the investors. We therefore believe that short-term funds are best suited for moderate risk appetite investors in the mid maturity bucket. For investors with a lesser investment horizon, we recommend investments in Ultra Short Term Plan. Duration funds are likely to well as we go into the first quarter of next year, albeit expected volatility caused by oil prices and fiscal/monetary policy action or the lack thereof.

We believe that at the moment, short-term strategies may not be best suited given that it is too binary and the outcome can go either ways. It is therefore ideal to look at the 1 – 3 year space.

What is your take on the 1 year, 2 years, 3 years, 5 years and 10-years yields in corporate bonds? Will you be a buyer in corporate bonds and what would be the tenure?
We believe that all the above stated tenures offer attractive yields/. However the 5 – 10 year because of supply and volatility in the underlying sovereign bonds will be likely to remain under pressure. The one to 3 year is therefore our preferred space in the current environment.

Where are you personally investing your own money? And why?
I strongly believe is asset allocation being the guiding principle for investments. I have allocation to asset classes like debt, equity, real-estate and gold as well. Within the fixed income space a significant part of my investments are in the short-term plan.

How has the flows been to fixed income funds and if they have been positive into which funds have you seen maximum traction?
We have seen significant flows into our FMP's as is the trend in the January to March period. Also market yields were attractive and therefore have got investors to invest significantly. We have also seen inflows into our short term and regular savings plans as investors looked for an open ended fund in the short to medium space.