Mutual Funds

‘Deposit rates are close to the peak'

M. V. S. Santosh Kumar | Updated on March 12, 2011

Mr Puneet Pal, UTI AMC

Investors taking exposure to one-year short-term income funds may get an effective annual yield of 9.75-9.8 per cent.PUNEET PAL, UTI AMC



Following the Budget announcement of the unanticipated cut in the market borrowing programme and a lower fiscal deficit target, we caught up with Mr Puneet Pal, Fund Manager (Fixed Income), UTI AMC, to seek his views on find out the impact of these government moves on the bond market.

Excerpts from the interview:

What is the impact of government borrowing programme for the next fiscal on the government yields? Do you believe the borrowing and deficit targets are realistic?

The government borrowing is lower than expected. Therefore over the last few days we have seen marginal fall in the yields. However, fall in yields will be limited because of the two factors. One is that the assumptions on deficit and expenditure of the government seem to be on slightly unrealistic levels. Very fine assumptions have been made by the government. Secondly, we feel that the government will find it very tough to stick to this fiscal deficit target in absence of any major revenue contribution in the next fiscal.

Is there any expectation of a surprise revenue stream for the government next fiscal that would help reduce the deficit target?

Not really as the spectrum auction proceeds are not available next year. The disinvestment target is also kept at the current year's levels. Only thing we need to watch for is the expenditure control the government can manage next fiscal.

As you can see, non-Plan expenditure is almost flat, which we think is unrealistic going by experience. Therefore, I think it is slightly difficult to stick to this target. Apart from the fiscal deficit, the yields may be influenced by factors such as inflation, which is still sticky.

The RBI is expected to hike rates this month and later on too. This combination of high inflation and high interest rates would translate into higher yields. Some upside in government yields can be expected.

Can depositors, therefore, look forward to reasonable inflation-adjusted returns?

From the depositors' point of view, most banks are offering rates close to 10 per cent. Earlier, when deposit rates were low, we had negative interest rates but now I think it has turned positive. We feel inflation will cool of from 8 per cent plus levels to 7 per cent. Therefore, your real interest rates will, in fact, improve by virtue of inflation coming down.

Are deposit rates after hikes close to their peak? Between short-term and long-term debt, which should investors choose?

Yes, the deposit rates are close to the peak. We are recommending short-term income funds as the short-term rates have shot up by more than the RBI expected.

With effective policy rates hiked by 3 percentage points, (from repo to reverse repo) the short-term rates have gone up by more than 4-4.5 percentage points. One-year certificate of deposit rates are at 10.25-10.3 per cent.

Therefore, investors taking exposure to one-year short-term income funds may get an effective annual yield of 9.75-9.8 per cent.

How will interest rates pan out one year down the line? Do investors face a risk of ending up with lower rates after one year?

It is very difficult to take a view one year down the line as there are so many variables.

For example, crude oil prices; if the situation in West Asia doesn't stabilise and Brent crude remains at $110 for 3-4 months, that can change inflation and fiscal situation for the worse quite dramatically.

Taking everything into account, investing in the short-term bond funds makes sense. One-year CD rates are very close to their peak. Similar levels were previously seen in 2008.

What options can retail investors look forward to? Will the corporate debt market deepen post the recent Budget proposal?

The participation of retail investors in corporate bonds, especially in infrastructure bonds, is encouraging. However, this is not so much because of careful asset allocation as due to the tax breaks. Going forward, if the government is really interested in deepening the corporate bond market it has to deregulate interest rates. Investors have to move out of bank deposits to these products. That will still take some time, though.

Coming to the Budget proposal of higher FII investment in corporate bonds, the incremental limit which is opened up is greater than five years.

We have not seen great participation by the FIIs in that kind of the segment. We have seen that those limits were not fully subscribed to, even in the last auction. So I don't know if increasing the limit will help.

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Published on March 12, 2011
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