Santosh Kamath, Chief Investment Officer, Fixed Income, Franklin Templeton Mutual Fund, shared his outlook on inflation and interest rates and spoke about how investors can navigate the rate cycle.
What is your outlook on the RBI`s benchmark interest rates after the recent hike? How much do you expect rates to rise?
Given the ongoing trends in inflation and the strong GDP growth momentum, we expect the central bank to continue step-by-step increments in interest rates. However, inflation and the global conditions will be key drivers, and this dynamic environment has been acknowledged by the RBI in its recent policy statements and the introduction of the new intermediate policy reviews.
It is difficult to quantify the hikes or the extent of the rate hike cycle, as the central bank tries to strike a balance between maintaining growth momentum as well as price stability, while keeping in mind the global factors.
Despite being primarily dependent on domestic drivers, the Indian economy has linkages to the overseas markets due to commodity prices (read imported inflation) and liquidity conditions (read FII/FDI flows and external borrowings).
Inflation has consistently remained above RBI targets. What is your outlook on inflation?
Recent trends in inflation have been driven by demand-side factors, in addition to the existing supply-side constraints that have been pushing food inflation. In a fast-growing economy such as India, inflation will be an ongoing issue due to expansion leading to capacity utilisation and infrastructure bottlenecks.
In that sense, we are going to witness these economic cycles on an ongoing basis, but the supply-side constraints need to be addressed by the government to provide stability.
In the near term, headline inflation may taper down as the base effect turns favourable. Good rainfall and healthy trends in sowing activity could also help bring down food inflation, going forward. However, we need to monitor global oil/ commodity prices, given that India depends on energy imports to a large extent to meet its requirements.
Is the prospect of rate increases factored into current gilt prices? What should be the trigger for investors to consider long-term debt and gilt funds?
The ongoing rate hikes have been largely factored into the 10-year gilt yield levels that have also been impacted by concerns about fiscal deficit. Yields have trended down after rising to 8% plus in April this year. Recent trends on 3G/BWA collections, partial de-regulation of fuel prices and good tax collections augur well for government finances and have cushioned the impact from rate hikes.
Rather than trying to time the interest rate cycle, investors should focus on building a diversified portfolio of fixed income products, in line with their needs and investment horizon.
Typically, investing in actively managed funds with a consistent track record should help investors ride the interest rate cycle in an efficient manner.
Three-month commercial paper (CP) rates have gone from 4.5% to over 7% in the last couple of months. Have short-term rates peaked?
The rise in CP rates reflects the combined impact of liquidity tightening, rise in repo rates and demand-supply factors (increased dependence on CP issuances post transition to base rate).
We expect some easing but the pressure on short-term rates is unlikely to reduce significantly as the RBI has indicated that systemic liquidity levels will be actively managed to ensure effective transmission of monetary policy.
What strategies have made the Templeton Short-Term Income Plan the top performer in its category?
TISTIP is focused on corporate debt, including securitised debt at the short end of the curve. The investment strategy for over a year now has been focused on taking advantage of spread differentials and accrual opportunities in various sectors of corporate debt.
Back in 2008/early 2009, amidst the global turmoil and the liquidity crisis in India, risk aversion resulted in a substantial widening of corporate spreads over gilts. The general view was to stick to government securities, given the the weak environment and fears of credit downgrades.
We felt that the concerns were overdone and were the result of temporary systemic liquidity issues, given that Corporate India`s balance sheets were largely in good shape. Hence, we adopted a combination of active strategies focusing on high accruals, shorter-duration paper and spread plays. We continue to use the same strategies to help our investors take advantage of the opportunities at the short end of the curve.
Have Indian companies managed to de-leverage their balance sheets sufficiently over the past year? How will they be impacted by rate hikes?
At a broad level, Indian corporate balance sheets were in reasonably good shape even before the financial crisis broke out. Many companies with a larger proportion of debt capital have taken advantage of the improved market conditions and raised equity. The rate hikes announced so far have not had a substantial impact on corporate borrowing costs.
Many of the large corporates have also been taking advantage of the increased rate differentials with developed markets by raising funds in overseas markets, and this could help some of them mitigate the impact on cost of capital. At a broad level, Corporate India appears to be well placed, with the exception of a few sectors.
Are sectors that were worst affected by the credit and global crisis, such as realty, retail and so on, out of the woods?
While the overall liquidity situation has improved, the concerns during the crisis period have resulted in a cautious outlook for these sectors.
We have typically been wary of the real estate sector and have avoided exposure even when the general perception was very positive few years back. A large chunk of real estate companies in India have highly leveraged balance sheets and, while retail prices have been on the upswing, the commercial space remains tepid.
What does the above interest rate outlook mean for investors? Which fixed income options should they consider now? Should they lock into current rates for a 2-3 year time frame?
Investors need to prepare for increased borrowing costs as well as higher deposit rates, and also need to focus on `real` returns, given the high inflation levels. Historical data suggestthat during a rising rate environment, typically strategies focusing on shorter maturities and corporate bonds outperform.
From our portfolio, we feel investors should consider such funds as Templeton India Short Term Income Plan and Templeton India Income Opportunities fund, along with ultra short-term funds or floating rate income funds, depending on individual requirements.
Investors need to prepare for increased borrowing costs as well as higher deposit rates, and also need to focus on `real` returns, given the high inflation levels.
Source: http://www.myiris.com/newsCentre/storyShow.php?fileR=20100816113224707&dir=2010/08/16&secID=livenews
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