Debt funds have run into a set of new uncertainties ranging from an oil price spike to a hawkish-sounding RBI. R Sivakumar of Axis Mutual Fund shares his views.

Are debt fund managers less bullish now than they were a year ago?

Not really. Look at where we were last year — election results hadn’t come through, there was rupee volatility, CAD was at a high, crude oil was at $100-120 a barrel. On all these macros, we are far better off this year than we were last year. Plus, we have gained this understanding that El Nino does not necessarily drive food inflation. It is more government policy on support prices that drives food inflation. So, from a bond market perspective, there is confidence that the RBI will cut rates. Even if inflation stabilises at 5 per cent and the RBI’s target is to get it to 4 per cent eventually, factoring in Raghuram Rajan’s real interest rate target of 1.5 per cent, we can still get to a repo rate of 6.5 per cent.

That creates room for further rate cuts from here and will support the market.

Why are G-Sec yields actually heading up?

Yes, 10 year G-Sec yields have gone up so far this year by 10-20 basis points. It is not as if the markets don’t see the macros as favourable. They do. But I think the markets are not able to read the RBI’s reaction to the macros.

I think one thing the RBI is concerned about is the Fed rate hike. Though the timing has been put off, rate hike possibilities remain. We saw in 2013 that when the taper announcement came, there was a lot of volatility in the markets. Maybe the RBI wants volatility to settle down before making any substantial rate cuts.

If the Fed rate hike happens, what will it mean for foreign flows into bonds?

Market expectations are currently very dovish on Fed rate hikes. Some market participants expect it in September, some in December. Some even think it won’t happen this year. As and when the Fed does hike, the participants who are dovish may have to make some quick adjustments. This is what led to the taper tantrum event.

But we do not expect any sustained flows back into the US due to this rate hike. We are at 7.25 per cent and they are at zero per cent. It will take a lot to bridge this gap. In the 2004-2006 rate hike, the US had effected a hike from 1 per cent to 5.25 per cent. It was the biggest rate hike ever. Then when the US rates were at 1 per cent, we were at 4.5 per cent — the gap was quite narrow. By the time they ended at 5.25 per cent we were at 6.50 per cent. With that differential of 1.5-3.5 per cent, India still received inflows.

But yes, in the near term, when the hike happens, we will see volatility. The risk from a US Fed rate hike on India will be transient.

Is the hike likely to be priced in before the event?

To an extent, yes. Last time around, the taper remarks were completely unexpected. This time there has been a lot of forward guidance from the Fed; therefore the impact is likely to be muted. Markets also get tired after a while of focussing on a specific risk. Look at Greece, which was big news five years ago, but no longer carries much impact.

In the previous rate cycles, the RBI’s policy rates fell to 4.75 or 5 per cent. Are rates likely to go to those levels this time around?

In the current scheme of things, that does look a bit difficult. There are some factors that could keep inflation high in the near term. Fiscal consolidation is getting delayed.

You also have a couple of other factors. It is unknown what the GST rate will be. But I am reading in some reports it could be as high as 26 per cent. Now GST subsumes many taxes — sales tax, excise and service tax.

If you are a goods manufacturer today you pay tax twice — excise and sales tax. In the GST environment, you will get VAT credit and the rate of tax will be reduced. In service tax the rate of tax is 14 per cent. That could straightaway shoot up to 26 per cent. That will have an inflationary impact on CPI, which is weighted towards services. The RBI may keep a watch on these factors in the near term. But the RBI wants to get inflation to 4 per cent by 2018. In a three-year window, you will probably see rates falling significantly.

How will the new monetary policy agreement between the RBI and the government change the rate view?

It is a very significant development. Such agreements don’t happen very often. The last time such an agreement was entered into, the government stopped monetising its deficits through treasury bills. That led to a multi-year impact on markets. This time around, the most important thing is that it restrains the government as much as it restrains the RBI.

It puts a huge amount of pressure on the government to not allow prices to rise above a certain level. That is a very positive development for the bond market.

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