RBI Scope for Rate Cut Drives IDFC Asset's Bullish Bond Call

  • Central bank may decide it prefers lower real rates: Choudhary
  • IDFC Asset likes bonds due in 5 to 9 years, 12 to 15 years

The Reserve Bank of India will have room to cut interest rates again as it grows more confident inflation will stay anchored, boosting the attraction of mid- to long-maturity bonds, IDFC Asset Management Co. says.

The RBI may decide it prefers real rates below the current level of around 2.5 percent, said Suyash Choudhary, head of fixed income at the Mumbai-based asset manager, which oversaw the equivalent of $9.6 billion at the end of June. Choudhary calculates the real rate by taking one-year treasury bill yields and subtracting average inflation.

“If global conditions remain benign, we think over a period of time RBI may settle for lower positive real rates in India, which may open up the scope for the next 25 or even 50 basis-point easing,” Choudhary said in an interview last week. “We do not see why not to buy bonds at this juncture."

The RBI cut its benchmark repurchase rate to 6 percent from 6.25 percent on Aug. 2 to help revive an economy held back by Prime Minister Narendra Modi’s steps last year to withdraw some currency notes. Some of the “upside risks to inflation have either reduced or not materialized,” the central bank said in its policy statement.

Indian consumer-price inflation accelerated to an annual 2.36 percent in July from 1.46 percent a month earlier, data released last week showed. That’s still down from as high as 11.51 percent in November 2013. The central bank targets a rate of around 4 percent on a medium-term basis.

Inflation still remains low in India and any pressure from the demand side is still absent, Himanshu Malik, a strategist at HSBC Holdings Plc in Hong Kong, wrote in a note Thursday. The bank has a long position in 13-year government bonds, as well as a received position in five-year offshore swaps, he said.

IDFC holds Indian bonds due between five and nine years in its longer bond portfolio, and also likes securities due between 12 and 15 years.

“As asset allocators, it is a good market to be in as volatility is low and you are getting decent carry on all places on the yield curve,” Choudhary said. “One should not prejudge how soon or late gains are going to come, as long as the environment is benign enough to continue to run positions.”

Key Views from IDFC Asset:

  • Inflation
    • We have seen reasonable undershooting of core CPI, and even if headline inflation goes up from here, which is much more of a certainty, there’s more confidence both with RBI and markets that we will broadly hit the RBI’s medium-term target of around 4% by the fourth quarter of this fiscal year
  • Bonds
    • Five to nine-year government bonds are absolutely attractive, but given we can’t call this an end to rate cycle, I also need some duration. That is where I get into the 12-15 year bucket to some extent.
    • One should keep a very open mind on this cycle yet and operate off underlying frameworks
    • We have exited our state bond portfolio in 10-year and above maturities as supply picks up over FY18 3Q and 4Q
    • Long-duration state development loans and Uday bonds have to be tactical trades. However, we continue to like these bonds up to 5-year maturities since the carry on offer is very lucrative
    • Even with this kind of liquidity and a 6% funding rate, the 1-year t-bill is at 6.20%. It hasn’t dropped within 5-10 bps of repo. As liquidity drains, we may see some flattening bias on the yield curve. It’s not as richly priced as expected with 2.5 trillion rupees of surplus liquidity, next to zero incremental credit growth, and 3.5-4% inflation
    • One is reasonably comfortable at running long positions
  • Liquidity
    • RBI has taken a very practical approach on liquidity
    • Current excess cash can be hardly called inflationary as there is hardly any credit happening on the back of it. Liquidity is largely being passed back to the central bank or going into bonds. The velocity on this money is quite low
    • RBI will look at FY18 3Q and 4Q currency in circulation before moving too aggressively to remove liquidity
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