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A Good Monsoon Will Stabilize Inflation

Ritesh Jain, Head – Fixed Income, Canara Robeco speaks to VR about the current market scenario

Ritesh Jain, Head - Fixed Income, Canara Robeco
Experience: 10 years

Expertise: Managed approx Rs 15,000 crore in fixed income and hybrid funds and Rs 50 crore in a gold ETF in his last assignment at Kotak Mutual Fund

View on interest rates: Inflation rate, price of crude oil and the current account deficit are going to determine the fate of the currency and interest rates in short term

View on inflation: A good monsoon should stabilise the inflation rate

On RBI not raising rates: The RBI is conveying that it needs to do a more careful analysis of the present situation before arriving at a policy decision.

How has the debt market evolved in the past 10 years?>The bond market can be divided into two broad parts: government securities and corporate debt. The G-Sec market has evolved to some extent. At one time it was only a broker driven market where deals were closed right up to 9-10pm. Now, fortunately, there is a finite time by which it has to be done. So the government bond market is well controlled by the RBI. Even the shorting system has been introduced whereby if anyone has a contrarian view on the market he can take a trading call.

Unfortunately, the corporate bond market has not developed to the same extent as it is still only an OTC market and the corporate bond repo market is yet to take off. One cannot trade big volumes in this market since there is no trading platform to give depth to the market. Today corporate bonds are traded only over the phone. Except for government bonds, all trading is done via the phone. So the transparency levels and price discovery mechanism do not exist. As a result the market is very small.

Had there been, say, interest rate futures then we would have seen a longer yield curve developing in a much more organised way. The cash market may or may not be a true reflection of where the market should be. But derivatives can provide the underlying strength to the cash market. With the non-existence of the derivatives market, one really cannot take a longer term interest rate call. Worldwide, the interest rate futures market is much larger than the stock market futures and that is what will eventually happen here too.

The good thing is that we have made the transition to a paperless system and processes are smoother and properly operationalised.

Your funds right now are very small. Is that a problem? Does a huge fund get large ticket deals, better rates, better cash management?
The cash market is very small. If you have to make big investment decisions in a relatively short period of time, it becomes difficult. Let's say a fund manager has Rs 10,000 crore. He has to buy Rs 500 crore of assets or sell the same amount. But the daily volume itself is Rs 500 crore to Rs 1,000 crore. Now if he wants to trade half of that, it is really not possible. So that money cannot be invested without a huge impact cost. Because he will not be able to pick up those instruments quickly in secondary market. And if it is, then it will not be in very liquid instruments. It is not possible to trade such huge amounts in the secondary market because of the cash flow requirements.

In the case of bonds funds too, it does matter to some extent how big the fund is. A small fund can do better than large fund. The advantage is not significant. In fact, if the fund is too big, the fund manager might have a problem in transaction costs associated with buying and selling corporate bonds in big quantities. Even corporate bonds are not traded in our market - Rs 50-100 crore is the daily turnover.

One big player can move the market by 5 basis points. Everyone wants to know who the counter party is. And then he may decide not to bid if the counter party is too strong a name. But once on the exchange, the volumes and liquidity will rise. And there will be no need to disclose the counter party.

In terms of your investment approach, how active are you?
In the long-term funds, I trade more in government and corporate bonds. A gilt fund would obviously be restricted to trading in gilts. And I do trade. If the market moves from 8.40 to 7.40 per cent and then back to 8.10 per cent and then to 7.90 per cent, one just has to trade at least some portion of the portfolio. And there are good trading opportunities. Government bonds are very easy to trade as the trading platform developed by the RBI is very investor friendly.

In a liquid fund, I prefer some portion of the fund being non-tradable and a certain portion to be used for liquidity requirements which will change on a day-to-day basis.

I believe it is easier managing a short-term debt fund than a long-term one. At least in the short end of the market there is a lot of liquidity in the papers. So you can enter and exit. But the long term corporate bond market is very limiting.

I have a bucketing approach. From June 15-30, money goes out due to advance tax. In addition, mid-September, mid-December and mid-March, money goes out. So at any given point of time I take stock of the maturities and cash I have. During these periods of tightness, I keep around 30-40 per cent in cash.

You were a trader before you became a fund manager. How has this helped?
A trader by definition must keep on trading. So a one-way market does him no good. But when you have a market that is very dynamic and changes quickly from one extreme to another and suddenly the system is flush with liquidity and the next day it has dried up, then you have to adjust to these changes rapidly and act accordingly. A trading background helps one adjust much more easily. You don't have the time to make a thorough analysis and go through a long drawn decision making process. Trading has made me an instant decision maker which is necessary in today's market.

Do you believe in actively managing the debt portfolios in a balanced fund or MIP?
No. We just buy and hold. The alpha generation will take place from the equity component. I actively manage my pure debt funds.

What is your investment approach, in terms of quality of paper?
The credit risk is taken care of by rating agencies. We are rated AAA by CRISIL, ICRA and CARE. When we buy, we keep it in mind that our rating must be retained. So when we purchase new credit, we run it through the agencies. Credit risk is very important especially in today's environment. When companies are in a capex mode, downgrades are inevitable. CRISIL stated that for the first time in five years we will have more downgrades than upgrades. So we have to be more selective in what we go for and be prepared to stick with it. We do a top-down approach. For instance, I would prefer a Tata Steel corporate paper on my book in spite of such a huge capex done by the company as the steel cycle looks good, the company is one of the most cost effective producers of steel and has a huge group backing.

Right now, what call are you taking?
I always take a top down approach. With global integration, capital flows move very fast from country to country looking for returns. Today the rupee has depreciated. At a time when everyone believes that the rupee should appreciate, it is depreciating. All Asian currencies except yuan are going down. In such a scenario the short term capital flows will not come to India. When a country's currency is appreciating, everyone brings in money to play on the appreciation. When it begins to depreciate, everyone wants to take out their money.

I am wary of the market now since there could be liquidity tightness. Inflation might not come down and the yield curve has already started moving back up. I have exited and will wait for another opportunity. Let the currency stabilise and the market consolidate at a level for around few days to give me a fresh look.

In such a scenario it is tough to take an investment decision for the long term. Inflation, crude oil and the current account deficit are going to determine the fate of the currency and interest rates, at least in short term. The country's central banker says that he is somewhat surprised by what has happened on inflation front. Who could have predicted that oil would go from $120 to $111 and will move back to $122 within a week? But I have to adjust my investment and portfolio to reflect all these movements. .

There is a lot of volatility in all markets. So my portfolio has to reflect this reality.

Let's say that oil shoots up by another $10 in two days. The rupee will go up to 42/dollar. Suddenly there would be expectation of liquidity tightness. I will have to sell something because money will go out from my fund. When the funds buy, they all buy together, but when they sell, then who do they sell to? A CP/CD market is dominated by mutual funds. When we have cash we buy from each other. But in a crisis who do we sell to? It's like a black hole. I would not like to be the last one out there selling. I might compromise a bit on my performance but would not like to add volatility to the fund at that time. I would prefer keeping a higher amount in cash. It could well be the case that the dollar moves up further. So in a rising inflation scenario we have a depreciating rupee. So imports, including oil, will now be costlier. So inflation may not come down. The market needs to have much more depth - coming back to my earlier point. If we want to exit we must have that option or we keep higher liquidity

What is your view on inflation?
It is difficult to take a short term call on inflation. We are at 7.5 per cent and according to the Sengupta Committee this includes the January prices of steel. If we incorporate March prices, it would be 8 per cent. Let's see what the monsoon brings us before I take a long term view. If we have a good monsoon, the inflation rate should stabilise. Of course in the long term inflation has to come down

You think the RBI had done a good job in controlling inflation?
What can they do that they have not already done? There has to be a balance between rate of interest and growth. Inflation has come up out of the blue. If we had permitted the steel capacity to come up five years ago or provided iron ore mines to steel producers and installed steel plants at that point of time, we would have had steel capacity. Cement capacity build up will be seen in a couple of years. So what is it that RBI could have done with a 25 to 50 basis point hike? Banking balance sheets would have added NPAs and defaults would have gone up. Consumers who had taken huge amounts of loans are already defaulting. In such a scenario you cannot increase the interest costs. But you have to do something. So they decided to suck out the excess liquidity in the system. If this liquidity is left in the system it will again move into the stock market and real estate.

Forty per cent of our import bill is oil. With current account deficit rising, if we do not keep the rate high our currency will get hit. Our money supply is growing at 21 per cent. So money supply will double in the less than four years. If we don't increase the supply of goods in this country then inflation will push through the roof. The banking system is going to double its deposits in the next 3½ years. Its deposits are growing at 25 per cent. Money supply should be 17 - 17.5 per cent to contain inflation. They have done the best they could do on all counts except keeping money supply in check. By not cutting or raising the rates, the RBI is saying that it needs to do a more careful analysis of the present situation before arriving at a policy decision.

What would cause interest rates to rise or fall now?
Lower inflation and less government borrowings.

What is the magnitude of risk in fixed income funds in the event of an interest rate hike?
The impact on short-term funds will not be too much. But it will certainly impact long-term funds. If oil remains high at $120, the current account deficit will shoot up. Higher current account deficit coupled with a high money supply is a lethal combination for any economy. To keep these two things under check, the RBI might go in for a rate hike.

Do you see corporate bonds making a comeback with bond yields falling?
They already have. But it has not happened in a big way due to lack of transparency and there is no order matching system. Nationalised banks do not trade too much in corporate bonds. The market is dominated by mutual funds and foreign banks. The market trades in very low volumes and CP/CDs are the only ones which trade in big volumes.

What would you recommend for a fixed income investor now?
The investment horizon is important to take this decision. Somebody with day-to-day cash surplus should invest in liquid or liquid plus funds. If the investment horizon is longer but the investor does not want day-to-day volatility, he can invest in a 3-month, 6-month or even 15-months FMP. Otherwise I do believe that income funds are an attractive investment proposition with an investment horizon of six months and above.