Don't see any major pressure as a result of the taper: Axis MF's Sivakumar

In a Q&A, R Sivakumar says the key drivers of foreign flows in India would be the inclusion of Indian bonds in global fixed-income benchmarks

The Reserve Bank of India has accumulated significant foreign exchange reserves to limit the volatility that may occur due to the taper tantrum, says R SIVAKUMAR, head, fixed income, Axis Mutual Fund. In an interview with Chirag Madia, he says the key drivers of foreign flows in India would be the inclusion of Indian bonds in global fixed-income benchmarks. Edited transcripts:
 
Do you think interest rate hikes by the RBI are imminent?
 
Since December 2019, average inflation in India has been over 6 per cent. Despite this, the Reserve Bank of India (RBI) has followed an accommodative monetary policy to support the economy, which has been affected by lockdowns during the pandemic. Now we appear to be past the second wave and there is an increase in the pace of vaccination. This should lead to normal growth in the months to come. With that, there will no longer be a need for this extraordinary monetary policy.

 

The RBI should begin the process of normalisation — through draining liquidity and increases in interest rates over the next few quarters.
 
What will be the impact of the US tapering on the Indian bond markets?
 
Just as in India we expect the RBI to begin the process of normalisation of monetary policy, we should expect the major global central banks to start withdrawing extraordinary tools such as quantitative easing. We must remember that the US Fed and other central banks are able to do this only in an economy that is strong.
 
As long as global growth remains on an uptrend, we do not see any major pressure as a result of the taper. As compared to the 2013 taper tantrum, this time around the RBI has accumulated significant foreign exchange reserves to limit the volatility that may occur if portfolio investment flows reverse for a period of time.

 
Do you foresee any kind of downgrades or defaults at India Inc?
 
Since the second half of FY21, we have seen more upgrades than downgrades. This happened because corporate balance sheets have improved after the 2018 IL&FS default. We have also seen policy support, including the government’s partial credit guarantee and the RBI’s support through targeted long-term repo operations, the moratorium, and restructuring. Lastly, the organised sector has outperformed the unorganised sector during the pandemic, which is supportive for corporate bond markets because listed bonds are issued by larger, organised players.
 
Over the last year, the best-performing segment of the bond market has been the credit segment — something most investors may not be aware of. We expect companies to continue to do well as the macro-economy returns to the growth path. It is likely that there may be some stress due to the second wave of Covid. We do not expect this to lead to widespread downgrades or defaults.

 
Given the current environment, how are you managing debt investments?
 
The yields on high-quality, short-term debts have been very low over the past year. In fact, these bonds have yielded well below the average inflation rate over the same period. To obtain a positive real yield, one has to either look at credit or longer-duration bonds. Credit (non-AAA bonds) has outperformed and we expect improving macro growth to further support this space.
 
Longer bonds have seen yields rise materially as the market prices in future expectations of rate increases. We expect these segments to form the core of our portfolios. We have also increased our allocation to floating-rate bonds because they benefit from a rising interest rate environment.

 
Foreign portfolio investment has been positive in debt even as we have seen some outflows from equities this quarter. Why so?
 
As always it is difficult to attribute reasons for short-term changes in flows from foreign investors. Over time we expect flows to remain strong. The key driver will be including Indian bonds in global fixed-income benchmarks, which will drive structural (mandate-driven) flows into India.
 
This year has been bad for debt investors. Will next year be better?
 
The low returns on bonds this year have been due to the very low interest rate environment. The effective overnight interest rate has been 3-3.25 per cent and the entire money market has been operating below 4 per cent. The bond market too has been affected because the market has been pricing in future rate increases by the RBI. Despite this, most categories of bond funds have outperformed cash this year. Most segments of the bond market now offer yields over the rate of inflation. As the RBI normalises monetary policy, even short-term debt such as money markets should begin to offer significantly better yields for investors.

 
What strategy should investors adopt at this point of time?
 
There is a rule of thumb in investing in bond markets — that the duration of the portfolio should be aligned with one’s investment horizon. In a rising interest rate environment, it is tempting to stay in cash or money markets. In the current environment, though, the sharp difference in yields between the money market and bonds makes it attractive to stay in bonds even in a rising rate scenario.
 
We have also seen a lot of fear of credits due to the downgrades and defaults seen in 2018 and 2019. As the economy comes out of the pandemic-led growth slump, credit too should form a core part of an investment portfolio.