In an interaction with Anurag Mittal, Deputy - Head of Fixed Income, UTI Mutual Fund

As Anurag Mittal, Deputy - Head of Fixed Income, UTI Mutual Fund, indicates in this interview, fixed income mutual funds still offer a multitude of added benefits such as better transmission of policy rate changes with the possibility of mark-to-market gain in periods of interest rate cuts or faster re-pricing during periods of rate hikes

What is your present evaluation of the Indian economy? Do you believe the Reserve Bank of India’s decision to pause rate hikes can be sustained for an extended period or is it premature to reach such a judgment?

India’s macroeconomic fundamentals continue to remain stable. The purchasing managers’ indices for manufacturing and services indicate expansion. High frequency indicators like passenger traffic, e-way bills, toll collections and fuel consumption are exhibiting buoyancy.  While there are near-term risks on account of the recent spike in food prices due to erratic weather patterns, they are likely to be transient and should fade out in the upcoming months. There are also idiosyncratic risks from unforeseen global externalities due to record high global interest rates.

However, our robust FX reserves should prevent any major volatility. We believe that it is important for long-term macro stability for the Reserve Bank of India (RBI) to demonstrate its commitment to inflation targeting. Hence, the RBI may remain in a prolonged pause till it has a strong visibility of inflation falling close to the medium-term target of 4 per cent or it sees a major demand shock requiring it to intervene to protect financial stability.

In June, debt mutual fund schemes experienced a net outflow, breaking a streak of two consecutive months of net inflows. What were the contributing factors behind this change in trend?

Fixed income mutual funds may typically witness outflows during months falling at the quarter end – with the pandemic years of FY21 and FY22 being an exception – as a certain class of investors tend to redeem for variety of reasons such as booking profits on their investments or optimising their banking balances, etc. which gets reversed in the subsequent months. In fact, fixed income MFs have received significant inflows in the month of July 2023, thus reversing the outflows in June.

Given the various regulatory and taxation changes that have occurred in the debt mutual fund category, do you anticipate a shift of investors towards traditional options such as bank fixed deposits (FDs) or other fixed income instruments?

While the indexation benefit was one of the most marketed feature of fixed income mutual funds and the taxation changes may initially lead investors to consider alternate instruments, fixed income MFs still offer offer a multitude of added benefits such as better transmission of policy rate changes with the possibility of mark-to-market gain in periods of interest rate cuts or faster re-pricing during periods of rate hikes along with high liquidity in funds without exit load and a diversified portfolio.

The US Federal Reserve has implemented a 25 basis points increase in federal rates, setting a target range of 5.25-5.50 per cent, which stands as the highest level since 2001. In your view, what are the reasons behind this decision, and what potential implications could it have on the actions taken by the RBI?

The Federal Reserve historically has had an inflation target of 2 per cent and inflation had been largely below their target. However, inflation sharply spiked as the global economy got disrupted during the pandemic due to both supply and demand side shocks touching a high of 9.1 per cent in June 2022, a level last seen in 1981. While it was initially expected that this inflation may be transient and would normalise as the economy would open up, policymakers soon realised that they would have to tighten financial conditions to slowdown aggregate demand.

Since March 2022, the Federal Open Market Committee (FOMC) has been tightening monetary policy as part of their effort to lower the stubbornly high inflation and align it with their 2 per cent goal. The aggressive rate hikes by global central banks do not have a direct or material impact on India as the nature of inflation here is very different, which is largely supply side and can be addressed only in the medium term by keeping a reasonably high real rate. That is something the RBI has been maintaining for a while now.

Can you share some insights on the short term and long term prospects for the debt markets? 

We believe that in the near term of the next 12 months, India is possibly going to move from high nominal growth and high inflation to moderate nominal growth and lower inflation regime this fiscal year. While it’s difficult to ascertain the timing of policy normalisation, the next major policy move is likely to bring policy rates lower rather than pus them higher. Given the current macro backdrop and reasonable valuations such as re-pricing of the yield curve, we believe that an intermediate duration of one to four years seems attractive. Assuming a well-behaved global commodity cycle, the long term prospects for the debt market look constructive as the government is committed to fiscal consolidation and the RBI has also demonstrated regular commitment to its inflation-targeting framework.