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Wednesday, November 03, 2010

The Current Steps Taken By the RBI Is Also Expected To Make the Corporate Bond Market More Liquid

Mr. Ramesh Rachuri, Sr. Fund Manager - Fixed Income, Bharti AXA Investment Managers 

Fixed Income Market Update & Strategy

Commenting on the second quarter review of the monetary policy for 2010 -11, Mr. Ramesh Rachuri, Sr. Fund Manager - Fixed Income, Bharti AXA Investment Managers, said “The Reserve Bank of India raised the Repo Rate by 25bps to 6.25%, and the Reverse Repo Rate by 25bps to 5.25%. It also continued with its liquidity infusing measures by announcing a buyback of Rs. 12000 crore of G-Secs on the 4th of November. It also increased the provisioning for banks' real estate loans. In addition, from the bond market perspective, it has also decided to “permit settlement of repo in corporate bonds' effective December 1st 2010 for which detailed guidelines will be issued. Further, RBI has also stated – “Based purely on current growth and inflation trends, the Reserve Bank believes that the likelihood of further rate actions in the immediate future is relatively low.” 

“Stubbornly high protein led food inflation, possible quantitative easing in developed economies which would drive up commodity prices, attenuating domestic demand to rein in the growing current account deficit were some of the factors considered in taking this stance. The immediate impact of the policy and the liquidity infusion measure caused the 10 year G-Sec bond to rally from a yield of 8.11% to 7.97% currently. Short term CD rates also softened as a result of pent up demand in waiting for the policy stance. 

Monetary authorities also try to target a ‘neutral' policy rate at which there is no slack in the economy in terms of potential output. RBI has also implied that after the present hike, the monetary situation is close to normal or neutral and further action would depend on evolving circumstances. So, unless inflation goes out of hand, or there is a ‘shock' to the system, RBI would prefer to wait and watch in the mid-quarter review on the 16th of December. What would then be a market mover in the bond and money markets would be liquidity. The current illiquidity in the market is also structural with the government of India parking its surplus of around Rs. 77,000 crores with the RBI. Essentially, the current buyback is being financed by using this surplus parked with the RBI. Unless the government starts spending, the current lack of liquidity (roughly to the extent of the above mentioned account) in the market would persist. The current steps taken by the RBI is also expected to make the corporate bond market more liquid. 

In light of the above, and given the expected pause in rate hikes in December (and possibly till the end of the current financial year), we would judiciously extend duration in our Bharti AXA Treasury Advantage Fund, and Bharti AXA Short Term Income Fund. In Bharti AXA Short Term Income Fund, we would endeavour to do this through a combination of buying PSU short tenor corporate bonds as liquidity in these securities would be higher than 1 year CPs (even though CPs would give slightly higher yields), and shorter tenor active and liquid G-Secs. This would enable us to exploit the high carry once the rates' settle down. On further external inflows in the bond market, these bonds would gain. We believe that our investments in higher yielding, longer duration securities, and an active trading and management of G-Secs and credit spread trading would substantially enhance returns over a one to three month period, in both the above mentioned schemes”.
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