Published on Tue, Dec 27, 2011 at 14:18
Article from CNBC-TV18
Updated at Wed, Dec 28, 2011 at 07:59
With all the noise around the government fiscal deficit target, borrowing programme and the general liquidity situation in the country, bond yields saw a sharp spike yesterday. Speaking to CNBC-TV18, executive director of Bank of Baroda, RK Bakshi says that with government borrowing increasing, bond yields will also have an upward bias. For the next quarter, the 10 year yield should average around 8.5%,” he said.
It is because of this that fund manager at Quantum Advisors, Arvind Chari asks investors to move out of fixed maturity plans to active funds. “Look at buying into income funds, bond funds or GILT funds which invest only in government securities,” he said.
Chari also asks fixed deposit investors to extend their maturities as the peak of the interest rate cycle comes close, because that will ensure higher returns and reduces the risk of reinvestment.
Below is an edited transcript of his interview with Latha Venkatesh and Reema Tendulkar. Also watch the accompanying video.
Q: This is a big jolt from 8.35% yesterday to 8.55% today. Where do you think bond yields will end the year itself?
Bakshi: The bond yields are susceptible to news flow quite naturally. Of course right from the beginning there have been doubts whether the fiscal targets will be maintained. We then saw the borrowing program increased to Rs 470,000 crore from Rs 417,000. So people are not sure whether it will stop at that or it will need more because alternate ways of funding the fiscal have not been able to fructify.
This Rs 15,000 crore announcement last Friday, although it is not clearly stated that it adds to the government’s total borrowing program, was not planned or calendared for this date. So this additional Rs 15,000 crore saw a big jump in yields from 8.34% like to 8.54-8.55% lines. There had been some worry there because they are all towards deficit or all to fund all companies, so that is keeping the market on tenterhooks.
Although the RBI has signaled lower rates, the government borrowing programs with the liquidity being what it is and OMO program being what it has been will definitely keep the market on up and down on news flow. Mainly it looks like if the borrowing goes onto increase, definitely there will be an upward bias.
Q: How much do you think banks like yours could be impacted due to rising NRE term deposits rates?
Bakshi: This is a big impact. It has come at a time when NRE flows had started improving because of the rupee rate becoming very attractive. Of course I cannot fault with the philosophical rationale of providing rates, but it has come at a time when the inflows have started increasing.
Q: So your margins will be hit?
Bakshi: Definitely, unless you are able to pass it on. But the credit sell is not definitely happening. We have just mentioned the quantum of increase. On a 3.5% deposit, if the increase is to 9%, then 5.5% is a major increase.
Q: Going into FY12 what's the kind of investment one should look into if you have to invest in debt?
Chari: We have been advocating investments to move from say money market funds or close ended fixed maturity plans (FMPs) into active funds. When I say active funds it would be investment into income funds, bond funds or GILT funds which invest only in government securities. We have been continuing to maintain that view because we all know we have a problem on the fiscal. Nobody believed that 4.6% number and the market still second guess as to how much will be the excess borrowing. It could be another Rs 40,000-60,000 crore of excess borrowing that the government can do, but it depends on how they are going to fund it. If the divestment route works out and SUUTI works out, then probably the demand for borrowing in the market will be lower.
Another thing that the government can do is to borrow through T-Bills. Given that we expect some reduction in CRR in either this policy or the next, that would mean that liquidity will not be as bad as it is currently. Government will spend, liquidity will come back to around Rs 1 lakh crore negative and RBI will continue to do open market operations to be able to keep the liquidity at +/-1. So a large part of increase in government borrowings can be through treasury bills and need not come to date at borrowings.
Q: Basically what does it mean for investors? Should they get into fixed income kind of funds, and within the fixed income category what are you advising? We are seeing a lot of mutual funds even offer FMP plans. What should an investor do for maximizing his returns on the fixed income front?
Chari: Let us take a normal investor who does not do mutual fund at all. So he is a fixed deposit investor, who is going to remain a fixed deposit investor. What we have been recommending them is to extend maturities at the peak of their rate cycle. So if you are doing 1 year FD or 1.5 year FD, extend it to 3-4 years. We have economic data points to point out that the economic down turn is there for sure, so RBI, if not now, will ease in the next 3-6 months. So rates are headed downwards despite the fiscal worries and worries on oil. So if you are a FD investor, extend your maturity so that you can lock in this 9.5-10% for a three year period and so your reinvestment in next year is that much lower.
If you are a mutual fund investor, depending on your risk appetite - long term government yields are volatile as you saw 9-8.24% and 8.25 8.5% in 3 weeks. So you will have to live with that volatility but the trend that we are seeing is downwards, yields are headed downwards despite the fiscal
Q: So which particular fund one should go through?
Chari: Depending on risk appetite, there are short term income funds which invest in 2-3 year maturities which are also available at 9-9.5% for an AAA PSU. So if you have less risk appetite but you still want to play, go into active funds because as bond yields come down, bond prices go up. So apart from the interest that you get, you also get capital gains.
Q: What is the name of the fund that people should look for?
Chari: It will be called short term income fund or short term debt fund. In the long term you will have long term income funds, which will invest both in government bonds as well as income funds. You will have to plan it based on your liquidity requirements. Even if you are doing fixed maturity plans, you should do it for a longer period, extend your maturity period.
Q: What are you expecting in the next quarter, the 10 year yield to average? Do you think it will go towards 9% or do you think it will remain between 8.25-8.5%?
Bakshi: On a balanced factor it should be around a median of 8.5%, it should not go towards 9%.
Article from CNBC-TV18