Floating rate funds can cushion interest rate volatility: Rahul Goswami

Goswami says case for normalisation of monetary conditions is starting to pick up pace, and next step will be to narrow the policy rate corridor closer to pre-pandemic level

Rising commodity and energy prices are the biggest risk in the medium term, says RAHUL GOSWAMI, chief investment officer (CIO)-fixed income at ICICI Prudential Mutual Fund. In an interview with Chirag Madia, Goswami says the case for normalisation of monetary conditions is starting to pick up pace, and the next step will be to narrow the policy rate corridor closer to the pre-pandemic level, all of which is likely to pan out over the next two to three quarters. Edited excerpts:
 
What’s your view on the debt markets, given the Reserve Bank of India (RBI) has embarked on liquidity normalisation?

 
The case for normalisation of monetary conditions is starting to pick up pace with the number of daily Covid cases declining, an aggressive vaccination rate, economic activity leading to growth picking up, the US Fed hinting at a taper, and higher commodity prices. The policy normalisation process began in earnest with the RBI not committing further to G-sec Acquisition Programme (G-SAP) operations and taking a staggered approach of increasing the quantum of variable rate reverse repo (VRRR) with an outlining option for 28-day VRRRs.
 

The RBI also mentioned that it would move away from passive liquidity management, which means that absorption of term banking liquidity may happen based on determined auctions. We believe the next step after the normalisation of liquidity will be to narrow the policy rate corridor closer to the pre-pandemic level, all of which is likely to pan out over the next two to three quarters.

 
What are the key reasons for the recent spike in the yields?
 
Yields have been largely tracking global developments which include the oil prices rising to $85 a barrel and US yields moving to 1.65 per cent levels. As a result, yields had started hardening even before the monetary policy committee (MPC) meeting.
 
On the domestic front, the RBI in its latest MPC meeting has communicated its intention of withdrawing from the G-SAP programme, even as it continues to support the government borrowing programme, including steps like open market operations (OMO) or operation twist. All these factors have led to a spike in yields. Due to the RBI's policy normalisation process, we believe the short-term rates may move higher, leading to the easing of the steepness of the yield curve.

 
Do you think there will be an impact of US tapering on the Indian bond markets?
 
The Indian government and the RBI have done a commendable job in accumulating foreign currency worth $700 billion (adjusting for forwards position) and creating a good safety cushion. Given that Indian macros are in great shape, we believe that India will largely remain insulated from steps like tapering of bond purchases by the US Fed. We continue to remain watchful of the trade balance and the current account data.
 
What strategy should investors adopt at this point?
 
We believe that we are at the start of the interest rate-rise cycle and in the current phase where growth and inflation dynamics are evolving, a relatively nimble and active duration management strategy is recommended as it may benefit from high-term premium (difference in the yield between the long and the short ends of the curve) and to manage portfolios from expected high-interest rate sensitivity. It may be an opportune time to invest in a floating rate fund that can cushion interest rate volatility.

 
An investor can also consider investing in an all seasons bond fund, wherein the fund manager has the flexibility to invest across the curve and make the most of the evolving market conditions. There is room for accrual strategy to play out, as well since better spread premium remains prevalent between spread assets and AAA and money market instruments. A savvy investor can consider investing in a credit-risk fund, as well.
 
What are the key risks facing the debt market today?
 
The key risk to the debt market is how the commodity and energy prices behave in the medium term. As India is a large importer of crude oil, any large spike there can change the trade balance and current account balance, apart from the impact on inflation. Another risk is the upward pressure on interest rates as it will impact the profitability of companies that are saddled with debt and also delay the pace of recovery, especially of those companies that are just coming off from the pandemic impact.

 
Do you foresee any kind of downgrade of defaults from Indian Inc? If yes, in which sector?
 
We are positive on the debt cycle, given that leverage is very low and that most of the corporations have deleveraged. Hence, we like the corporate sector from the overall cycle perspective.
 
Currently, the risk of defaults/downgrades has decreased significantly as the pandemic induced restrictions have been relaxed. According to a recent Crisil analysis, the credit ratio (ratio of upgrades to downgrades in credit ratings) — which is an indicator of the financial health of corporations — registered an increase to 2.96 between April and September of this financial year. It was 0.54 in the corresponding period last year, thereby indicating an improvement in the credit profile of the issuers.

 
While the overall development pertaining to the credit quality of corporations have been predominantly positive, some sectors have faced the adverse impact of pandemic-induced stress, mainly contact, movement, and occupancy-intensive sectors (services sector). The impact of lockdown on the SME sector, too, had been significant. While the issuers engaged in these sectors have shown a marked improvement, investors should exercise due caution.