A 50 basis points cut in the cash reserve ratio (CRR) is not sufficient to address structural illiquidity issues in the system, believes Amandeep S Chopra, Group President & Fixed Income Head at UTI AMC. In an interview with Vishal Chhabria and Sheetal Agarwal, he talks about the investment strategies and outlook for the debt market. Edited Excerpts:
What is your call on debt markets and interest rates trends? And did the CRR cut take you by surprise?
To some extent the CRR cut did take us by surprise. We thought that any policy actions before clear signs or trends are evident in terms of inflation slowing down will be little premature. But, the markets became fairly optimistic the moment you saw last two inflation numbers trending downwards. I think the CRR cut is not going to address any significant liquidity issues in the very short term because Rs 32,000 crore is not a meaningful impact when your liquidity adjustment facility (LAF) continues to be over Rs 1.4 trillion. Secondly, the impact of CRR cut is more over a couple of months; it sort of spreads out over a quarter. So, the immediate impact is not there. It’s also not leading to any lowering of borrowing costs for the bank.
So, while people have started expecting that the lending rates will decline we don't see that happening. I think, overall at best it’s more of a symbolic gesture which has improved the sentiments in the market. Structural illiquidity, which RBI also highlighted, is very much here to stay. So, that liquidity shortfall is going to be here for not just this fiscal but well into next fiscal year as well. I think a lot more is needed to be done.
On one side you have the government which is in a tight spot as fiscal deficit is tight, revenues are coming down so putting all that together how do you see things moving for the debt market?
In the very short term we have not seen too much of a reaction by the markets. There was an initial bout of enthusiasm in the 10 year G-sec which rallied a bit, the short term rates have also fallen by about 10-15 basis points across different maturity buckets. But the key factor which was helping support the rally in 10 year yields was actually the open market operations (OMOs). And there was very little clarity both in the policy and even in the press conference post policy on how the OMOs will be conducted for rest of this fiscal year. So from the immediate three month perspective you will see the 10 year largely reacting to the announcements on the OMOs.
If you have fairly active OMO operations by RBI then the 10 year will again revert back close to 8.10-8.20 odd levels. In case they focus more on the CRR impact over the next one or two months, and less on OMOs then these 10 year G-secs will revert back to the pre-December levels of close to 8.5.
The next big event in our view is going to be the Budget and the mid-term review on the 15th of March. You are also going to see close to Rs 65,000-70,000 crore money moving out of the system because of Advance Taxes. That is again going to put a lot of pressure on the system. So, that combined with Budget is going to be a very strong reason for another CRR cut. I think, they need to do another 100 basis points (bps) of CRR cuts to really address this issue about core structural illiquidity in the system. We are looking at possibly another CRR cut of another 50 bps.
Given that rate cuts are inevitable in FY13, how do you reposition your portfolio in that scenario?
We are looking at duration funds like the bonds funds, short-term income funds which can now capture this gain when RBI starts cutting rates. Even if they (RBI) indicate maybe on 15th March or closer to the April date, markets are going to factor in much early because it’s not going to be a single cut. So you will actually see markets rally well ahead of the 2nd or the third rate cuts. Some of that capital appreciation of the price movement can be captured by the bond and the gilt funds and also the short-term income funds. On the liquid funds, progressively the reinvestment will start taking place at lower rates. So the performance of those funds will decline. Thus, our view is that one a six months to twelve months view we think the duration funds will outperform the liquid category of funds. So we are positioning by increasing duration on the funds where we think they can capture this rate decline.
Within your portfolio strategy are you doing some churn in favour of lower rated paper where yields are now higher?
When we started this financial year we were risk averse and focused on credit quality because clearly the economy is slowing down, and you have started seeing part of that in the financial performance of most of the corporates. So, margins are compressing, EBITDA/Debt ratios are actually declining and our view was that to play safe in terms of credit but focus more on duration. Going ahead, we are looking at selective increase in playing credit and still stay long on duration. We will take selective exposure but we still think that corporate performance is going to be an issue for another two quarters.
So while you will see interest rates decline but the impact in terms of their financial health improving will be some time away because 50 bps decline in repo rate is not going to lower the base rate of banks by 100 bps. They are also going to be a little sticky. On the way down the rates are a little sticky. So I think if you see at least 100 bps of repo rate cuts along with CRR cuts its only then that the base rates will decline meaningfully enough for the financial charges for most of the corporate sector to decline and make their ratios on DSCR and so on more attractive from a ratings perspective. That is still two quarters away. So we are not gung ho and jumping into reducing our credit profile.
Any other strategy you are following to maximise returns and beat the average returns?
One is very clearly trying to get the interest rate calls right Second is to ensure that you pick up credit which would not get downgraded and at least benefit from a credit upgrade story. The third strategy that we are following is trying to identify new credits. There is decent arbitrage available in the sense that lot of corporates who were typically going overseas to borrow because the rate of funds was much lower have actually started coming back on shore because of lot of foreign/lending entities are shrinking their balance sheets. We are going to use that very actively. We have actually looked at a lot more newer names than we had over the previous six months.
How are your funds placed in terms of the paper quality and average maturity?
In terms of average maturity, all of them (three funds) would be nearing their highest levels that you would have seen over the last five years. In the bond fund, our average maturity will be around 8 odd years, in the gilt fund it will be between 9 to 9.5 years. The short term fund will be little over 2.4 -2.5 years.
There will be little bit of tactical changes every now and then like when we find some trading opportunities. The base case will be long on duration and do little bit of trading like this. And then keep identifying new credit.
Broadly what are the key concerns that you see both domestic and global front which would have a bearing on the debt markets?
First concern is an external event which is how the global macro and specifically the issues in the Euro actually pan out. We have seen some impact of that in terms of lot of offshore borrowing returning to onshore. So far it’s been manageable. In case it really deteriorates our concern will be that lot of this offshore borrowing will come onshore for either rollovers or refinance. That will put a lot of stress on domestic financial markets. Even the banking sector may not have sufficient capability to fund that and even so for the markets. While we are expecting rates to decline and spreads to narrow as we go into an interest rate easing cycle, it may actually not be as linear and as smooth as we expect simply because of this very large borrower suddenly coming onshore. So that can put lot of stress on the domestic markets.
The second is on the fiscal deficit front. That number continues to surprise us on the upside. Our concern is that next year if you continue to have very high expense structure in the government balance sheet then clearly that is going to continue to put a drain in terms of pre-emption of funds for government borrowings and very little available for growth and investments. And that in turn will not lead to the decline in yields and spreads that we are expecting. So it’s very important for the government as well to step in and ensure that they manage their balance sheet and their P&L well. Because if you have rate cuts not followed through with investments then clearly the core issue of inflation will not be addressed, which will then force RBI to again go back into a tightening cycle or again move from a growth to an inflationary stance. That will be a big worry from a fixed markets perspective.