Debt funds have made the best of the financial market environment over the past year by generating returns of close to 30 per cent. But can similar returns be generated from hereon? Mr Nandkumar Surti, CIO, Fixed Income, JPMorgan Asset Management India, is confident of capitalising on rallying bond prices arising from falling yields. In an interview with Business Line, Mr Surti explained his outlook on interest rates and talked about the corporate bond market scenario.

What is your view on interest rates? Do you expect further rate cuts? How much and over what time-frame?

In the current environment, two important factors come into play — slowdown in growth and falling inflation.

Both these factors are conducive enough for interest rates to move southwards. The RBI will have to cut interest rates to get the economy back on a growth trajectory.

Lower interest rates would encourage consumer spends and corporate investments, which would bolster the economy.

Inflation is expected to slide down below 3 per cent by the end of March 2009, which would give the RBI more leeway to cut interest rates.

We expect the central bank to cut the reverse repo rate and the repo rate by 100 bps in the next three months.

While the RBI has been steadily cutting rates, there appears (from the Q3 numbers) to be little respite for corporates on the interest cost front? Why?

In the last few months, risk aversion has increased considerably, capital availability has reduced drastically and liquidity has tightened significantly.

All these factors have led to widening of corporate spreads and a resultant increase in the cost of borrowing for corporates. Therefore, in spite of huge rates cuts by the RBI, interest burden remains high for the corporates.

Is the ECB relaxation expected to make foreign borrowing easier for local companies?

Currently, the credit spreads of Indian corporates are at an all-time high. As explained, the availability of funds, even for highly rated companies, is tough in the current environment.

Unless we witness return of risk appetite among the investors which, in our opinion, will take some time, corporates will find it difficult to raise funds despite ECB relaxation.

The 10-year gilt had bottomed at 5 per cent and gone up later, hurting bond prices. Are gains in gilt investment going to be difficult from here on?

The month of January has been very volatile for government bond markets. The reversal was essentially on account of an additional borrowing programme announced by the government.

With 3G auction now being suspect, there is a further possibility of additional borrowing. This uncertainty over borrowing in a short time-frame is causing volatility. Once the negative news is absorbed, there is a very high probability that the yields of government bonds will fall further due to expected rate cuts by the RBI.

Debt funds over the past quarter have given huge returns. Is this sustainable over the next few quarters? What are your return expectations in debt over the next one year? What are the expectations for your active bond fund?

We expect yields of government bonds to move south in the next few months. There is an inverse relation between bond prices.

As yields drop, bond prices rise. Investments in bond/ gilt funds therefore should be an extremely attractive proposition. We cannot however comment on the return expectations.

JP Morgan Mutual’s Active bond fund has seen an increase in portfolio maturity. Does this lead to higher downside risks to NAV, given that interest rates are yet to clearly move in downward direction?

We would like to reiterate the fact that we expect the RBI to cut rates further to limit the downside risk to growth.

In our opinion, the probability of growth coming below 7 per cent is very high. Global slowdown and uncertainties, falling exports and slowdown in consumption might bring down growth below this level.

On the inflation front, we expect it to be below 3 per cent and even getting in the negative zone in the first quarter of 2009-10. We expect a host of data on the industry side to be negative in the coming months.

Therefore giving the current background and expectations of a soft interest rate regime, we have increased the duration of the portfolio. This would help us to take maximum advantage of falling yields.

Would you consider corporate bonds as a primary investment option going forward?

Currently, the credit spreads of the corporates are at an all-time high and do make an attractive investment option.

However, corporate bonds currently carry relative liquidity risk. In addition, the current economic background warrants caution thus making us more selective on the choice of credit. Therefore, one will have to strike a balance between good quality corporate portfolio and gilts.

Given the current earnings environment and a not so high interest cover, what level of risk do you perceive in the corporate debt market?

Agreed, given the current economic environment, corporate bonds carry relatively higher risks.

However, the true scenario will emerge only after the current quarter. As such, we are currently restricting our investments to high quality liquid PSU/quasi sovereign debt papers.

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