By Lakshmi Iyer
My key expectation hinges on how much fiscal slippage is there in the budget. The fiscal numbers are very important to us because it will tell about the extent of market borrowing coming our way. The borrowing will further tell us the direction of bond yields. These are related numbers.
Given the headline inflation, the probability of rate cuts is going to be a challenge in the very near term. Therefore, the fiscal maths is very important for the bond market. That’s why it will be the most important thing to look at in the upcoming budget. That’s where all the attention will be focused.
However, I would not say that the market is excessively worried about the fiscal slippage. Yes, the market will be closely monitoring the quantum and degree of the fiscal slippage. If it is going to be a half per cent slippage to 3.8% for this year, broadly it will be okay. If it goes to 4.0-4.5% by the next year, I think that’s going to be depressing for the bond market.
If this happens, we will see yields moving up. Then we will have to see what kind of antidote markets get in form of operational twist. A combination of all these things is going to be a driver for the bond markets. The budget is important, but I think the debt market will take stronger cues from the monetary policy announcements by the Reserve Bank of India.
We have two bhramastras in the debt market: liquidity and the rate cuts. The year 2019 saw a series of rate cuts and I believe 2020 will be more dependent on liquidity. If the liquidity remains comfortable, I would recon that the yields will remain under control. Rate cuts might see yields getting lower. However, the quantum of rate cut that we saw in 2019 is not likely to repeat in 2020. The caveat here is a much more protracted slowdown in response to the corona virus. That could be a material game changer. Right now, nothing significantly ominous, but we need to watch out.
What is important right now is that we monitor the degree of slippage and direction and the quantum of a rate cut we get. And the timing of rate cut is important. Apart from these, there are credit issues in the market. However, I believe that 2019 was the peak of credit issues in terms of magnitude. Issues haven’t been resolved completely but I think there is a resolution in sight to the problems because of IL&FS issue that percolated to the NBFC sector.
There might be cases this year also, but in terms of the magnitude I don’t think we will see a repeat of 2019. The year 2020 could be when we could see bulk of resolutions. But this will take time, the spread might not compress in a hurry.
Long duration bond funds saw a rally because of the rate cuts that we saw last year. I believe the return expectations from these categories should be moderated. The potential for performance still remains, but the extent may not get repeated. As I said, the rate cut expectations are lower than last year. So, debt investors should be aware that there might be volatility and the returns may not be as high as last year. One should have a minimum three-year horizon before contemplating investments in these funds.
I would like to tell all the debt mutual fund investors that the budget is just another event and they shouldn’t worry about it too much. Your asset allocation shouldn’t depend on what happens in the budget. I think in this market, clustering investments in categories like short-term, corporate bond, PSU Funds is a good strategy, with a tail-end or small allocation to credit-risk funds. Stick to fundamentals. Don’t time the market or go overboard on a particular category.
(As told to Shivani Bazaz)
(Lakshmi Iyer is the Chief Investment Officer (Debt) & Head Products at Kotak Mutual Fund)
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
