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WF: Global eyes are on the US Fed as it winds down its QE and anticipation is building up over a turn in the US interest rate cycle. What are your expectations on US interest rates and what implications could this have on emerging markets in general and India in particular?
Nandkumar: I guess this is going to be a key issue to track going forward, across emerging markets, including India. The market is right now pricing in a rate hike in US in 2015 middle. If either the hike comes in sooner, or sharper than expected, the surprise aspect is what can cause volatility. That's what happened in July 2013 - it was a surprise that caught the market off-guard.
From a US stand point, first quarter GDP growth was -2 % and the second quarter GDP growth was +4%. At JP Morgan, we believe that US is going to exhibit good strength in terms of its economic data. If you look at retail sales or automobiles sales, they are almost back to the pre crisis period volumes. Housing data also is reasonably strong, as is labour data. One should keep a close watch on data and on Fed meeting minutes to get a perspective on when the rate hike cycle will commence. We are clearly moving in the direction of a rate hike - we need to watch this space.
Coming to the second part of your question, which is the impact on emerging markets, as I said, it is more the surprise element if any that has a sharper impact than an event that is already priced in. Moreover, we in India, are in a much better shape now than we were in mid 2013, when the Fed first hinted about its QE tapering. Our currency has rebounded by over 10% from its 2013 lows, we have a strong and stable government at the centre, clear measures have been taken to control current account deficit. So, I don't think we are too vulnerable to a turn in US interest rates. What we need to be watchful about is near term impact of any surprises.
WF: If carry trade becomes more expensive once US begins hiking rates, can it impact FII flows significantly?
Nandkumar: There are two aspects. US Fed is winding down its QE - which means stopping incremental injection of liquidity. They haven't made any statements about withdrawing the liquidity from the system. No Central Bank is interested in destabilizing markets and I think any talk of liquidity withdrawal is still very premature - its probably something that will happen a couple of years down the road.
Then you have the EU and Japan, which have their own versions of QE in place. So, I think discussions around contraction of liquidity are too premature right now.
WF: Moving to the domestic scenario, while RBI has refused to give a signal on cutting rates in the near term, expectations are high that inflation will soon come within RBI's comfort zone, which will lead to a rate reduction cycle in the coming months. Do you share this optimism? What is your call on domestic inflation and interest rates?
Nandkumar: I am very bullish on interest rates dropping in India - but I am bullish from a 24 month perspective. If you look at RBI, there are two milestones which RBI has setup. One is Jan 2015 where they are expecting CPI to be at 8% and the second is Jan 2016 which is a commitment of 6%. For this to be achieved, one good part is as I mentioned earlier there is a very strong mandate at the Center. Now RBI obviously expects the Center to deliver on a few things and when you look at CPI inflation there were 3 important aspects which were affecting CPI inflation.
First was the MSP which is the Minimum Support Price on agricultural produce, that had to be capped - there were some very unreasonable increases that had happened over the course of last few years. That has been taken care of, this time the increase in MSP has been just about of 3% or thereabout. The second aspect was the wages and NREGA. The Government has committed that even while the employment is guaranteed under NREGA, this will have to be on productive usage and not just creating employment for employment sake. This will help temper inflation, as productive assets will be created.
Two important aspects of CPI have been controlled and the third aspect is you need support from the rain gods. We started badly this season with monsoon deficit of 40%, as we speak we are somewhere closer to 20% and the MET expects between now and the end of the monsoon season the rainfall is expected to be as per the past trends. If that happens we will end the year probably at 15% and thereabouts deficit on rains. If you look at crop sowing, its around 2% below compared to last few years average. So if rains are going to be good from here, monsoon situation should not be bad, that means that the agricultural prices which have galloped in the month of July, should be more reasonable in the months to come by. The Government is attacking agricultural inflation on the front foot, they have announced various measures in terms of curbing black marketing and also releasing central food stocks.
You have a Central Bank which is extremely committed, you have a Government which is extremely committed. I guess what bond markets has ignored is the correction in oil prices by nearly 15 dollars. Now that's a big, big positive. If oil prices are sustained at these lower levels, you could have zero subsidy on petrol and diesel and very marginal subsidy now on natural gas and kerosene.
So, if CPI is on course to reduce to 6% or thereabouts by Jan 2016, interest rates have to come down sizeably by then, from where we are today. I believe, this gives very good opportunities to invest in debt markets - provided you have some appetite for volatility.
WF: Is it time for duration strategies to become the key focus area within debt funds or is it still too early to take that call?
Nandkumar: Absolutely, this is the time. The challenge always is that many investors look at past returns before investing, rather than looking ahead. One thing however that investors tend to ignore about debt markets is that this is one market - unlike equity - where you have an anchor investor with a clear interest in minimizing volatility, and that is the Central Bank itself. Every Central Bank tries to keep volatility in interest rates to the minimum as it directly impacts economic activity. Volatility is therefore very temporary in nature in bond markets. Investors must understand this and take a slightly longer term view.
10 year G-Sec yields have rarely crossed 9% in India, and the current yields of 8.5% or thereabouts offer a very good opportunity to come in with a 2 year perspective into duration strategies that can capture a downtrend in interest rates over the next 2 years.
WF: With the recent change in tax laws, do you see duration based funds losing some appeal, as these are unlikely to be held for 3 years to avail tax benefits?
Nandkumar: You know, we are a young nation with the largest proportion of population in the under 30 age group. We ought to be talking about investment planning with a 10-20-30 year perspective, not a 1 year vs 3 year perspective!
Now, lets take the tax break aspect. I looked recently at our own short term bond fund. It's an all weather fund - and yet average holding period is 9-10 months. People were not waiting for the 1 year to get over, when LTCG was at a 1 year period.
So, I guess the broader issue is that all of us need to work harder with distributors and investors to encourage them to stay invested for much longer periods than what they are currently doing. If tax nudges them to stay longer, maybe its good for all.
For an investor coming into a duration fund now, I am confident that over a 3 year holding period, there is an attractive risk adjusted return to be made.
WF: Corporate bonds are now becoming increasingly popular in the fund industry and there is a perceptible increase in risk appetite and a willingness to ride the ratings curve. Do you share this enthusiasm for less than AAA rated corporate bonds? Do you see sufficient value in this segment?
Nandkumar: Definitely I share the enthusiasm, but not probably to the extent that some segments of the market are exhibiting. I have reservations on few assets. Corporate profitability is on the upswing, the general economic conditions have bottomed out. So there is definetly merit in looking at corporate bonds below the AAA category with a probably steady rating or a rating upgrade story. So that is definetly important but more important is also the valuation or the pricing of these bonds and that's where the challenge is essentially coming in.
Spreads should be attractive taking into account the relatively lower levels of liquidity and the reality that in many cases, such bonds have to be held to maturity. So, unless the pricing is commensurate with the relative illiquidity, its not that attractive from a valuation perspective.
I am actually far more comfortable lending directly into corporate balance sheets rather than pursuing structures and asset backed securities. One has to take into account the risk-reward trade off when looking at structures. More diligence is called for in security selection.
Disclaimer: The opinions/ views expressed herein are the independent views of the interviewee and are not to be taken as an advice or recommendation to support an investment decision. The information included in this document has been taken from source considered as reliable; JPMorgan Asset Management India Pvt. Ltd. cannot however guarantee its accuracy and no liability in respect of any error or omission is accepted. These materials have been provided to you for information purposes only and should not be relied upon by you in evaluating the merits of investing in any securities or products mentioned herein.
The information contained in this document does not constitute investment advice, or an offer to sell, or a solicitation of an offer to buy any security, investment product or service. Investment involves risk. Past performance is not indicative of future performance and investors may not get back the full amount invested. As an investor you are advised to conduct your own verification and consult your own financial advisor before investing.
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