The following interview appeared in 2012 edition of the India Fund Observer, our yearend publication. To read the e-magazine, click here.
Morningstar spoke with Rahul Goswami, CIO - Fixed Income, ICICI Prudential AMC, to get his views on the economy, growth, inflation and the bond market.
How would you sum up 2012 from the debt market perspective? Were there any unexpected developments during the year that surprised you?
2012 was about walking the tightrope of managing inflation and growth with more focus on inflation with the headline WPI number averaging at around 7.5 % range.
It was also about aggressive steps taken to keep the liquidity deficit in control by RBI where they reduced CRR by 175 bps through the year and the SLR requirement for the banks by 100 bps in the same period. Hence CRR plus SLR cumulative liquidity easing has been to the extent of 2.75% of the NDTL.
Apart from this, RBI also reduced the operative rate which is the repo rate by 50 bps. All of this has definitely led to some softening of rates specifically on the credit side where banks have been able to reduce the lending rates
Finally it was about fears of a downgrade that was mitigated in time by the government taking steps on containing fiscal deficit. Most significant was the adjustment in the oil price, specifically diesel by more than 10% at once.
The biggest surprise in the last year was the fiscal deficit number which was much more than anticipated and which has in turn makes it imperative for the government continue working towards fiscal consolidation.
What is your outlook for the fixed income markets in 2013? What according to you may be the key concerns/factors affecting bonds this year?
With inflation moderating from peak level and WPI inflation averaging at around 7.5% for the full CY 2012, we expect a very high probability of inflation in 2013 averaging to around 6.5% to 6.75%.
Also with growth continuing to remain low and the investment and credit cycle both remaining subdued, we expect GDP growth for CY 2013 to remain muted at around 5.5%-6.00% levels.
Statistically, while we may have seen the bottoming of growth at 5.3% we are unlikely to see any strong revival in growth in light of factors mentioned above
With inflation expected to moderate to below 7% levels, the focus of the central bank is expected to shift towards growth revival. We expect a 100 bps reduction in the operation rates by the RBI through the reduction in repo rates through the year.
The key concerns of RBI would be the elevated current account deficit which has been averaging in excess of 5 % of GDP and trade deficit which continues to be USD 17-18 billion a month. This is clearly the biggest concern which if continues can potentially lead to depreciation in currency, unless countered by very huge portfolio flows.
There have been talks of reduction in interest rates for a while now. When do you expect RBI to start cutting rates, and by how much during the year? What are the hurdles that RBI has to overcome before it can start cutting rates and how do you see the rate cycle panning out in 2013?
The biggest expectation from the debt markets in 2013 has been of reduction in rates. 2013 is well poised to meet this market expectation albeit overcoming a few challenges specifically on the fiscal deficit and current account deficit front.
On the positive side, with inflation having moderated, there is more headroom for RBI to reduce interest rates in the coming policy. We expect RBI to cut rates over the next 3 months to the extent of 50-75 bps.
Given the scenario at present, do you think that the government will be able to stick to its new fiscal deficit target?
The government’s initial fiscal deficit budget estimate was of 5.1% which was later revised to 5.3%
While meeting the 5.3% deficit target in the current scenario could be a little difficult, we do not expect a significant overshoot. The steps taken over the last 4 months like hike in diesel prices, changing in the pricing of LPG and opening up markets in FDI retail and insurance has clearly indicated strong commitment and intent from the government to continue to work towards containing deficit. This will help avoiding any significant overshoot.
In continuation of the above question, do you expect the central government to increase its borrowing further in FY 2012-13? What will be its impact on bond yields?
We expect possibility of the government borrowing going up by INR 15000-20000 Cr, however, this can be taken into stride by the market. Also with deficit and system borrowing by the RBI continuing to remain close to INR 1 trillion on a daily basis, we expect RBI to take steps towards liquidity management through a combination of to do some more open market operations (OMO’s) & reduction in CRR.
The direct impact of the rate cut on the yields will be that the curve which now appears to be very flat with 1 year T Bill trading at around 7. 95%, 10-year trading at around 7.85 % and 30 year bond trading at 7.75-8 % range will start to steepen.
If the rate cuts are slow and calibrated, the yield curve will steepen albeit gradually. Overall we believe that there is potential for 10 year bonds to come down by 30-40 bps through the year.
How do you see the liquidity situation panning out in 2013? What are your views on open market operations (OMOs) during the year?
The system liquidity remains in deficit and is likely to average in excess of INR 1 trillion through the quarter. For the two quarters of April-June & July-September, we may see some improvement in the liquidity scenario due to government spending.
This still may have to be supported by RBI through OMO’s and also by reduction in CRR by RBI for the scheduled commercial banks. So roughly, through the year 2013 we expect Open Market Operations not less than of 2% of NDTL i.e approximately INR 140,000 Cr.
Which segment of the market--gilts or corporate bonds--do you expect to perform better this year? Can you also share the factors which are expected to affect them?
We believe that there will be phases through the year when both government securities and corporate bonds will do well. In the 1st quarter we expect government securities to outperform corporate bonds because of balance sheet considerations and relatively low supply of government bonds.
However, corporate bond performance is expected to catch up in the next two quarters after that because of improvement in liquidity and sentiment. However, we do not expect corporate bonds to be able to outperform G Secs in a big way unless a big change in liquidity stance happens from the central bank where it changes its operative rates from repo to reverse repo.