Topic 4: Keeping money in bank deposits is no longer attractive
Bank FD rates for short term deposits have plummeted to close to savings account rates in many banks, and may remain soft for a while given the overall sluggish environment. Money should start flowing into debt funds offering superior risk adjusted returns, feels Ritesh. The current market is paying increasing compensation for taking prudent risk – a case in point from his data on spreads is the spread that’s still available in AAA corporate bonds even as PSU bond spreads have seen significant contraction since their March 20 levels.
There may appear room for more rate cuts, given that growth is weak and with demand destruction there is a case for disinflation. It seems that RBI’s accommodative measures were directed at rates and were aimed at easing overall financial conditions. It is a signal that RBI is fully aware of the current stress in the financial system and will do what it takes to ease the conditions. In the current backdrop of a very weak fiscal condition, as expected RBI is doing a lot of heavy lifting in terms of rates and policy measures and we can continue to expect that RBI (and government to the extent possible) will not lift the pedal off the accelerator until the economy begins to revive.
While the gradual release of lockdown and resumption of economic activity is positive, it is only so at the margin. Therefore, we expect RBI support to continue until there is a strong recovery in growth and therefore can expect more rate cuts and accommodative measures like OMOs (open market operation) , operation twists etc. to absorb G-sec supply.
Also it is imperative to note that, bulk of the rally has happened in the short-medium part of the curve. The longer end of the curve (10yr and beyond) has not seen a commensurate rally, despite the 115 bps of rate cut (75bp and 40bp) since the lockdown and a total of 200bps in the last one year. This is driven by overhang of uncertainty particularly on the fiscal side.
On a fundamental note, economies target growth rate needs to be > borrowing rate (G-sec) to not get into unsustainable debt trap. Therefore, to kick start growth and to keep debt on a sustainable basis, it will be necessary for RBI to keep rates (and therefore borrowing rates) lower for a prolong period until there is strong pickup in growth. Along with, there are many multiple variables at play that determines the overall yield curve move. We continue to remain constructive on the rates but still like the front/medium part of the curve factoring in those risk/return trade-off.
Indian bond markets do see a material impact from global markets predominantly from a) flows via FPI in both equity and debt b) impact on the currency front with resultant impact into current account deficits. Overall, global risk on scenario will benefit India, as flows into the equity and fixed income positively impact currency (keeping currency stable or avoiding undue volatility), and also helps in absorption of debt supply.
With liquidity continuing to remain in surplus mode, and expectation of RBI measures (such as OMOs) ensuring that liquidity remains in surplus mode, we believe current risk reward is favorable in the short/medium part of the curve. Longer end of the curve has an overhang of supply driven by fiscal constraints. The overall curve will remain supported via switch operations, OMOs, twist operations and buyback but value appears in the short/medium part of the curve.
In the credit spectrum, we would expect one to tread with caution and be mindful of the risks. While ratings are an indication of the credit risk at a point in time, it is not forward looking and different rating agencies have different methodologies. Therefore, investors should go beyond ratings and be mindful of refinancing risks and illiquidity as well.
From overall environment perspective too, it no longer pays to keep your money locked up in a bank. Fixed deposit (FD) rates have plummeted in recent months, with short-term rates now hovering very close to or below savings account rates for some banks. Surplus liquidity and sluggish credit growth have forced banks to cut rates of both short-term and long-term deposits. With deposit rates dropping so low, we do see flows starting to move to cash and debt mutual funds- which still remains potentially one of the better avenues to park surplus for investors and offers best in class risk-adjusted returns.
There may appear room for more rate cuts, given that growth is weak and with demand destruction there is a case for disinflation. It seems that RBI’s accommodative measures were directed at rates and were aimed at easing overall financial conditions. It is a signal that RBI is fully aware of the current stress in the financial system and will do what it takes to ease the conditions. In the current backdrop of a very weak fiscal condition, as expected RBI is doing a lot of heavy lifting in terms of rates and policy measures and we can continue to expect that RBI (and government to the extent possible) will not lift the pedal off the accelerator until the economy begins to revive.
While the gradual release of lockdown and resumption of economic activity is positive, it is only so at the margin. Therefore, we expect RBI support to continue until there is a strong recovery in growth and therefore can expect more rate cuts and accommodative measures like OMOs (open market operation) , operation twists etc. to absorb G-sec supply.
Also it is imperative to note that, bulk of the rally has happened in the short-medium part of the curve. The longer end of the curve (10yr and beyond) has not seen a commensurate rally, despite the 115 bps of rate cut (75bp and 40bp) since the lockdown and a total of 200bps in the last one year. This is driven by overhang of uncertainty particularly on the fiscal side.
On a fundamental note, economies target growth rate needs to be > borrowing rate (G-sec) to not get into unsustainable debt trap. Therefore, to kick start growth and to keep debt on a sustainable basis, it will be necessary for RBI to keep rates (and therefore borrowing rates) lower for a prolong period until there is strong pickup in growth. Along with, there are many multiple variables at play that determines the overall yield curve move. We continue to remain constructive on the rates but still like the front/medium part of the curve factoring in those risk/return trade-off.
Indian bond markets do see a material impact from global markets predominantly from a) flows via FPI in both equity and debt b) impact on the currency front with resultant impact into current account deficits. Overall, global risk on scenario will benefit India, as flows into the equity and fixed income positively impact currency (keeping currency stable or avoiding undue volatility), and also helps in absorption of debt supply.
With liquidity continuing to remain in surplus mode, and expectation of RBI measures (such as OMOs) ensuring that liquidity remains in surplus mode, we believe current risk reward is favorable in the short/medium part of the curve. Longer end of the curve has an overhang of supply driven by fiscal constraints. The overall curve will remain supported via switch operations, OMOs, twist operations and buyback but value appears in the short/medium part of the curve.
In the credit spectrum, we would expect one to tread with caution and be mindful of the risks. While ratings are an indication of the credit risk at a point in time, it is not forward looking and different rating agencies have different methodologies. Therefore, investors should go beyond ratings and be mindful of refinancing risks and illiquidity as well.
From overall environment perspective too, it no longer pays to keep your money locked up in a bank. Fixed deposit (FD) rates have plummeted in recent months, with short-term rates now hovering very close to or below savings account rates for some banks. Surplus liquidity and sluggish credit growth have forced banks to cut rates of both short-term and long-term deposits. With deposit rates dropping so low, we do see flows starting to move to cash and debt mutual funds- which still remains potentially one of the better avenues to park surplus for investors and offers best in class risk-adjusted returns.