Globally, the Russo-Ukraine war and domestically, the budget and monetary policy outlook are creating uncertainties. The domestic macroeconomy is struggling due to the lockdown that started two years ago. But the economy was running weak even before the pandemic hit. As a result, the three-year compound annual growth rate (CAGR) of real GDP was barely above 1% for the first nine months of this fiscal. This poor growth has been accompanied by relatively high inflation, which has averaged close to 6% for the past two years – a situation close to a stagflation. It is understandable, then, that the focus of both fiscal and monetary policy is on reviving growth.
Fiscal policy can be a suitable tool to push real growth upwards. Monetary policy, on the other hand, affects nominal growth. Keeping inflation high gives one a sense of growth, but it carries a real risk of reinforcing expectations for higher inflation. As a consequence, market expectations of the future course of interest rates have risen sharply in recent months.
Added to the complicated domestic situation is the war in Europe. The extreme price rise (in some cases doubling or more) in many commodities in the recent past has the potential to disrupt our economy as we are a net commodity importer. Petrol and diesel prices need to adjust, and perhaps food prices will do the same. The rupee has fallen to the lowest level ever against the dollar.
The concern in the near future is about the rise in commodity prices and their impact on inflation. However, a war is an unnecessary destruction and is more likely to prove deflationary than inflation in the medium term. The impact on both cases will be limited if it is a short conflict as opposed to a longer lasting one. Assuming that the invasion ends in short order, we should expect to see some normalcy in the objects soon. We should expect volatility in the near future, but the focus will be on the domestic macro in the coming months.
As inflation remains high and with some upside risk from currency depreciation and commodity prices, we should expect the Reserve Bank of India to eventually start raising interest rates. Large government lending programs will also begin to affect bond yields as the market will find it difficult to digest the supply of bonds. We would like to be on the defensive in this environment, preferring a shorter duration.
As growth returns, the macro environment for debt (i.e. non-AAA bonds) is likely to improve. In our view, this segment is already one of the strongest performing segments owing to high returns and short duration. We expect this rate to continue through the cycle.
Investors should look for funds where the portfolio duration is less than the intended holding period. The period roughly represents the interest rate sensitivity or “re-pricing” period. In a rising interest rate scenario, if the holding period is longer than the period, the effect of reinvestment (i.e. the maturity of the bond being reinvested into the new higher-yielding bond) is marked-to-market (i.e. a rise in rates due to the increase in value). decrease) effect.
For a short-term investor, suitable segments could be overnight, liquid, money market and ultra-short-term debt funds. Investors with a medium term (like 6 to 24 months) can consider short-term, floater and short-term segments. Investors with tenors of more than 3 years should consider allocation to longer-term schemes such as target maturity funds, but some credit risk through credit risk schemes as well as other schemes with active allocation to non-AAA bonds You should also consider taking
R Shivakumar is the Head of Fixed Income, Axis Mutual Fund.
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