Mr. Santosh Kamath
Managing Director and Chief Investment Officer at Franklin Templeton, Fixed Income in India
Mr. Kamath oversees the fixed income functions of the locally managed and distributed debt products. Mr. Kamath earned his M.B.A. from XLRI, Jamshedpur in the year 1993 and his Bachelor of Engineering degree in electronics and telecom from REC, Bhopal.
Debt Fund Manager Questions:
Q. Please evaluate the current debt market scenario? How is the liquidity in the markets?
Answer: The inflation trajectory appears to be headed south mainly due to lower food and crude oil prices. CPI inflation for the month of December came at 18-month low of 2.19%, which is considerably below RBI’s revised inflation projection of H2FY19 of 2.7-3.2%. Core inflation also moderated to 5.70%. The correction in crude oil prices may help keep the inflation low, along with the winter crop yield. Improving consumption demand and expansion of industrial activity augurs well for the growth of the economy. Higher capacity utilization in select sectors, along with better demand conditions show improvement in economic conditions. Lower oil prices, if sustained, may also impact growth favourably.
The year started with surplus systemic liquidity and it remained near the neutral level. In September ’18, system liquidity was in deficit and became a cause for concern. The liquidity deficit in the banking system has moderated from the beginning of the New Year. The improvement in the banking system liquidity can be ascribed to the Open Market Operations (OMOs) conducted by RBI, easing of year-end and festive season demand for funds and the increased central government spending. The RBI has undertaken OMO purchases totalling INR 1.56 trillion during the previous 4 months (Sept-Dec’18) and total OMO purchases so far this fiscal (Apr-4 Jan’19) have totalled INR 1.97 trillion. RBI also announced continued liquidity support till March 2019. The overall liquidity in the banking system is likely to improve further. Going forward, we expect the RBI to ensure that liquidity remains around the neutral level, in line with its current stance.
Q. Please highlight the key developments taking place for the Indian debt markets in the year 2018.
Answer: Bond markets started off 2018 with an expectation that the RBI may continue with its neutral policy stance. The first half of the year saw trade wars, geopolitical tensions, volatile global markets, depreciating INR, higher crude oil prices lead to higher yields. Sticky inflation led MPC to hike repo rate by 50bps in two tranches in June and August.
In September markets were increasingly concerned about asset-liability mismatch on Non-Banking Financial Company (NBFC)/ Housing Finance Company (HFC) balance sheets. Tightening liquidity condition had pushed up borrowing costs, for NBFC and HFC lenders. Further, investors turned risk-averse after this experience, which had dampened overall market sentiment. Concerns around fiscal slippage, tight liquidity conditions, NBFC saga and a change in policy stance to calibrated tightening led to an upward move in the yields.
The RBI and government announced multiple positive moves that have directly/indirectly provide liquidity support to NBFCs. RBI incentivized bank lending to NBFCs by increasing the ceiling for lending to a single NBFC by an additional 5% of their capital funds. Recent liquidity measures by RBI, lower inflation, a sharp correction in crude oil prices, appreciating INR and lower borrowings have alleviated the pressure on yields. These slew of measures by the RBI and the government provided support to the market.
The spreads between the 10-year benchmark and repo rate were as high as 174bps, reflecting cautious approach by market participants. 10-Year AAA and AA-rated corporate bonds maintained an average spread of 80 bps and 134 bps against the 10-Year G-sec bonds in 2018. The average spreads widened towards the last quarter of the calendar year primarily on account of the liquidity crisis. The 10-year benchmark yield closed at 7.37%, 3bps higher than the beginning of the year.
Q. There are some concerns about the fiscal situation prevalent in the market. What is your take on same?
Answer: In the first eight months of FY19, India's fiscal deficit target has overshot by 15%, largely due to a revenue shortfall. The current run rate of the government's GST revenues is tracking a shortfall of INR 70,000-80,000 crore against the annual budget. In a year of general election, farm relief packages for farmers have been announced, this may pose a risk to meet the fiscal deficit target.
Revenue slippages are expected on GST but the possibility of getting higher nontax revenue may not be ruled out. Disinvestment proceeds may exceed the target for FY19, sizeable corpus has been raised via the ETF route. Certain expenditures can be deferred in terms of payments to the next year to meet the deficit target.
Despite fiscal deterioration, the government 10-year bond yields have come down sharply over the past few months, from a peak of 8.25% (during September 2018) to 7.37 % (on December 31). Besides easing liquidity conditions, the sudden softening in global crude oil prices, an appreciation in Indian Rupee has helped the bond market.
Q. How do you assess the current bond yield levels from the valuation perspective?
Answer: With inflation below RBI’s target level and global crude oil correcting, we expect the yields to continue to soften, whilst exhibiting some amount of volatility. RBI mentioned a host of provisions to address the liquidity conditions in the NBFC and HFC sector. The market may draw comfort from these measures and the spreads, which had widened in the recent past, may compress gradually. We believe that if inflation continues to be benign and global conditions remain conducive, the Monetary Policy Committee (MPC) may consider changing the stance back to neutral in the next meeting. We expect a 25bps rate cut in H2CY19 if the crude oil prices remain low and there is a normal monsoon.
However, raising US bond yields and strengthening USD, have resulted in bond outflows from EMs in the recent months. Growing concern over the Centre's fiscal position, especially ahead of the interim budget announcement on Feb 1, with lower GST collection and reports of relief packages for farmers, may continue to pose a risk to the above view.
Q. What would you advice to investors exploring traditional options like PPF, NSC, NPS, etc. as against debt funds at this time?
Answer: Investors need to objectively maintain asset allocation. Therefore some allocation to traditional assets may be advised. Investors should allocate a certain portion in fixed income funds as well, the mutual fund industry is well regulated by SEBI.
Q. What would be your advice to investors with short, medium and long term investment horizons in debt funds? Where should they invest?
Answer: Short-term maturity instruments look attractive from a valuation perspective. From an investment perspective, we suggest investors (who can withstand volatility) to consider duration bonds/gilt funds for a tactical exposure over the short-term horizon. We continue to remain positive on corporate bond funds and accrual strategies. Investors who are looking for accrual income opportunities may consider corporate bond funds that offer higher yields.