Wrap up of debt market in 2020
The year 2020 was marked by covid-19 related fallout across global economy. Policy makers around the world were forced to pump prime their respective economies to limit the damage and stimulate the economy back to normal. In India, bigger support came from monetary policy side rather than fiscal policy due to government’s constrained fiscal capacity in the pandemic.
Overall, the year was marked by RBI’s entry into the realm of ‘unconventional’ monetary policy. It got accelerated post outbreak as central bank tried to alleviate the market fears as was witnessed in stressed credit spreads, through various conventional and non-conventional measures. This has not only created a much lower policy rate which sets the floor for the interest rate structure in the economy. It has also affected various premia – term premia, risk premia, liquidity premia etc.
Currently, there is a lot of liquidity in the debt market as many investors have invested in fixed income funds post market rally. Will the trend sustain? Your views.
This liquidity is largely result of RBI intervention (estimated to be around Rs 7.7 trillion, Apr -Dec 2020) in both the bond and forex markets at a time when this action was in line with policy objective of using liquidity as first line of defence against any possible contagion and push transmission of lower policy rates to stimulate demand in economy during pandemic. It also served the purpose of augmenting forex reserves and avoiding sharp appreciation of rupee amid very healthy foreign inflows.
The concern of sustainability of such high liquidity is coming from the fact that traditionally inflation targeting RBI has managed liquidity tightly even when policy stance has been neutral/ accommodative. So, an untimely reversal of this extremely accommodative policy is a risk for market but as can be seen from central bank’s policy stance, they are clearly willing to err on side of caution by giving priority to growth and financial stability in near future. Any reversal in this will be gradual and with an intent of avoiding reversal of transmission of rates achieved till now. However, one should not expect current levels of liquidity to sustain for very long period.
Your outlook for 2021
The monetary policy support seen post covid-19 has been very impressive. However, we need to ascertain whether the covid-19 crisis will have a lasting impact on setting monetary policy objectives. Inflation right now has taken a back seat, rightly so, but as growth recovers in line with central banks own projection, we will have to revisit growth-inflation dynamics with inflation reclaiming its importance in monetary policy objectives.
We have been of view for some time that rate cut cycle is over and most of the action from the central bank will be beyond rate cuts as has been the case in the last couple of months. The main policy objective remains supporting growth along with management of inflation expectations. In the near term, we expect money market & short-term yields to stay range bound whereas the medium to long end of rate curve despite huge supply and inflation concerns will remain supported by asset purchases/ intervention from the central bank.
Which category of funds should MFDs recommend at this juncture?
We recommend funds with high credit quality in the low to short duration risk category like low duration funds, short term debt funds, banking and PSU funds. We recommend systematic deployments in medium and long duration funds for investors with longer investment horizons only.
