Mutual Funds

All eyes on the monsoon

Sudhir Agrawal | Updated on August 03, 2014 Published on August 03, 2014

Even as the moderation in CPI has brought relief, the deficient monsoon is a worry



The RBI, in its last monetary policy statement, has reiterated its commitment to bring down CPI to 8 per cent by January 2015 and 6 per cent by January 2016.

Acknowledging that the upside risks to CPI inflation remain, it has hinted at the possibility of stronger government action on food supply and better fiscal consolidation.

This may counter the negative impact of a weak monsoon and unexpected rise in fuel prices.

Overall, the RBI’s tone has been less hawkish than in the recent past. In the recent Budget too, the Government has vowed to bring down fiscal deficit to 3 per cent of the GDP in the next two-three years. It has also set an ambitious target of 4.1per cent fiscal deficit for the current year.

No major policy action

We expect the RBI to draw comfort from the recent fall in the core CPI inflation in the monetary policy review slated for Tuesday. We have seen the CPI inflation for June 2014 coming off to 7.31 per cent from 8.28 per cent a month back.

A lot of this fall is attributed to the high base of the previous year. However, the core CPI has also come off significantly to 7.4 per cent, which may come as a relief for the Government and the central bank. But as the monsoon remains deficient, we expect the RBI to keep policy rates unchanged.

The central bank may also wait to see the impact of change in the monetary policy stance of the US Federal Reserve on emerging markets’ stability. Overall, the RBI may watch the CPI data for the next 8-12 months before changing its policy stance.

Market awaits clarity

However, debt markets are not enthused by all these positive factors due to the worries on monsoon and lack of clarity on how the revenue targets of the Budget will be met.

The 10-year benchmark G-sec has been trading in a narrow band of 8.55-8.75 per cent. The market awaits more clarity on the monsoon picture as a bad monsoon may adversely affect the inflation situation.

We expect the new 10-year benchmark G-sec to trade in the 8.35-8.60 per cent band in the near term.

However, the medium-term trajectory of the yields will depend on how the monsoon behaves from here.

Due to the recent change in taxation treatment of long-term capital gains, we have seen some pressure on yields in the one-to-three year maturity segment.

However, as the yield net of hedging cost remains attractive for FPIs, this may keep the short end of the yield curve supported.

We expect the RBI to manage overnight liquidity actively keeping the overnight rates at close to repo rate level of 8 per cent. Overall, money market rates are expected to remain low and trade in a narrow band as liquidity may continue to remain easy in the coming months due to continued forex flows into the country.

Short-term opportunity

Investors should consider allocating a portion of their funds to short-term income funds and income opportunity funds to benefit from high accrual and lower volatility. They may also consider investing in Income funds with an investment horizon of 12-24 months as we may see prices of long bonds moving up on efforts of the new Government to bring down inflation.

The writer is Fund Manager – Fixed Income, UTI Mutual Fund

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