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With valuations and macro-fundamentals in favour, there lies a strong case for investing in fixed income at this point in time.
Currently, the Indian economy is in much better shape, with a stable current account deficit (CAD), downward-looking inflation, higher forex reserves and growth impulses picking up. Macroeconomic improvement and fiscal prudence could bring down interest rates over the next two to three years, building a case for investing in the debt market.
Yet, the RBI maintained status quo on repo, reverse repo and MSF rates in its monetary policy review. The policy came through with some positives on held-to-maturity (HTM) and liquidity coverage ratio (LCR) norms for banks. While the RBI looked more confident on meeting the inflation target of 8 per cent by January 2015, we believe that CPI inflation may touch 6 per cent earlier than the RBI expectation of January 2016. A bout of optimism can be derived from the latest inflation numbers.
Rewards for persistenceApart from inflation, factors such as CAD, fiscal deficit and liquidity are also tilting in favour of debt markets. In the April-June quarter (2013-14), the CAD moderated to 1.7 per cent from 4.8 per cent of GDP last year and is expected to be maintained at 1.5 per cent this year.
The narrowing CAD translates into higher savings in the economy, paving the way for lower inflation and interest rates. Furthermore, the Government has set the fiscal deficit target for this financial year at 4.1 per cent of GDP, giving a roadmap for lowering it to 3 per cent over the next three years.
India is also undergoing a liquidity-driven economic cycle, with substantial FII inflows across debt and equity markets. The improvement in liquidity may keep the overall yield curve in check and bond yields at lower levels. Expect the 10-year benchmark yield to be about 150 bps lower from current levels by the second quarter of CY2016.
A value propositionThe RBI delaying the monetary softening is clearly providing the time to investors to increase allocations toward fixed income. The Indian fixed income market has valuations as well as macro-fundamentals in its favour. This makes a strong case for investing in long-duration funds for attractive returns in the next two to three years.
The writer is CIO-Fixed Income, ICICI Prudential AMC
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