Fixed income markets' attention has moved from a "will he - won't he" question to "when will he", as speculation continues on the timing of RBI's much awaited rate cut. Whenever it finally happens, the broader issue is what next? Many advisors remember the period 2001-2003, where debt funds delivered healthy double digit returns for 3 consecutive years. Can we look forward to an action replay of that scenario over the next 3 years? Sujoy is quite optimistic that the environment is becoming conducive for that kind of a bonds bull market to take shape. Read on to understand what underpins his confidence that acchhe din are ahead for bonds - not just for a few months, but for a much longer period.

WF : Most conversations on fixed income these days seem to center around the date when rate cuts will begin. Rather than speculating about this event, can you give us a broader 3 year view on how you see fixed income markets shaping up? Where do you see, for example, the 10 year G-sec yield and CPI in 3 years time and what will be the key drivers from a long term perspective?

Sujoy : The shift of benefits from producers to consumers due to lower oil prices globally, will continue to support a benign imported inflation for India. As shale oil technology moves towards lower cost of production, the tilt in the dynamics of oil prices appears at a very early stage of a long drawn tussle. As these change in commodity cycles can take years to reverse, we expect the present lower prices to continue till the Middle East (ME) countries are able to sustain these levels without tipping into budget deficit.

The moderation in the Minimum Support Price (MSP) hikes and part amendment to the Agricultural Produce Market Committee (APMC)Act for keeping fruits and vegetables out of itsambit, has also effected a moderation in the domestic inflation. Both the above reasons arelikely to keep inflation in check in the foreseeable future.

We expect RBI to begin the rate reduction cycle beginning early 2015 and reduce rates steadily over the following 2-3 years.

With improved attractiveness of India as a compelling investment strategy, RBI can aim for real (inflation adjusted) interest rates toeventually contract to 1% - 2%. We can expect to see the 10 year benchmark closely trail the repo rate over the following 3 years.

WF : If US begins hiking interest rates in 2015, and given the current strength of the US dollar, should we expect much less FII appetite for emerging market debt, going forward? How will this impact our currency and bond markets?

Sujoy : The belief of a prolonged low oil prices scenario in the international markets may keep fed away from any immediate requirement of rate hikes. We expect the US to continue to have the present rate of inflation and hence do not expect slowing down of inflows from foreign investors to India. With inflation in India on a softer trajectory, there shouldn't be much worries on currency front and with increasing forex reserves we expect India to move towards a 9-10 months of import cover over the next2-3 years, which will only lend more stability to the currency and attract more flows into the country.

WF : One factor that is not really attracting too much attention is the outlook on the Government borrowing program over the next 1 to 3 years and its impact on liquidity in the markets. What is your perspective?

Sujoy : Given the likelihood of high real GDP growth together with the program of fiscal consolidation to reach the target fiscal deficit of 3% of GDP by FY17, the borrowing programme of the government is likely to become less of a botheration for the economy. The tax buoyancy in the market is expected to improve over the next 3-4 years and lend support to the government treasury.

WF : We saw a huge bonds bull market in the 2001-2003 period, where investors earned healthy double digit returns for 3 consecutive years. Can we expect a similar story to play out over the next 3 years? In what ways is today's situation similar to 2001? In what ways is it different?

Sujoy : The journey this time could be similar to the experience of 2001-2003. The similarity is that RBI dropped the repo rate by 250bps then from 7% to 4.50%.This time again, we can expect similar decline if the CPI headline settles at 4% on a sustainable basis. The difference is that the real rates in 2001 were close to 300bps and gradually contracted to 50bps from 2001 to 2003. This time around the real rates are not so high and we were around 100bps about a year back. The world is far more connected now.

WF : What are the key risks you see for our fixed income markets, going forward? What can pop the bond party?

Sujoy : The regulations around gold imports and efficacy of financial inclusion hold the key to the present bond rally. Asset creation is important and should not give rise to a situation of glut as demand presently outstrips supply of financial debt assets.

Protracted periods of Quantitative Easing (QE) in Japan and slowdown in Euro region can pop the bond party as the risk aversion may continue to strengthen the dollar,directing the foreign flows to developed markets. However, the domestic investors' risk appetite is likely to increase in due course as RBI goes dovish on its stance on interest rates.The concerted efforts of the RBI and the Government to maintain lower inflation hold the key to future economic growth and any puncture in the capacity expansion, with India moving towards becoming a manufacturing destination with 'make in India' initiative; is a big risk that can trigger an early set-in of price rise cycle.

Share this article