Exposure of Debt Mutual funds to Government securities (G-secs) has increased to 12.13% of the total Assets under Management (AUM) under debts securities as on February 28, 2015 - the highest since data was made available by the Securities and Exchange Board of India (SEBI). A year ago, G-secs accounted for only 6.2 per cent of debt AUMs. Let's check out why fund managers are increasing their exposure to G-secs.
 

 

RBI expected to reduce rates....
The RBI is expected to reduce interest rates further on the backdrop of improved economic conditions and softening of inflation. Fund managers are investing in longer duration papers to reap the benefits of a reversal in this monetary policy stance.

The yield on the benchmark 10-year government security has come down from 9% levels during the start of the financial year to 7.76 at present. There can be further downward movement, if interest rates are eased further. On the backdrop of improving macroeconomic scenario, mutual funds might be expecting RBI to lower interest rates.
 

Let's see what macro-economic indicators point to...
 

• Inflation: Softening inflation on the back of lower global oil prices has given RBI a lot of breathing room to reduce interest rates further. The price of Brent Crude has dropped around 50% from USD 120 per barrel to USD 55 per barrel. WPI inflation has decreased to -2.6% which indicates that rapid price escalation might be behind us. However CPI inflation has increased to 5.17 % and there is a high risk of CPI inflation speeding up with a possible rise in food prices. Prices of certain foods such as fruits and vegetables are expected to rise due to erratic weather conditions and unexpected rainfall this year. If crude oil prices rise because of any geopolitical uncertainty, it could spell trouble for India.
   
• Current account deficit: Speaking about CAD, after widening in Q2FY15 to USD 10.1 billion (i.e. 2.1% of GDP) from USD 7.8 billion in the previous quarter; for Q3FY15 CAD data dipped to USD 8.2 billion (i.e. 1.6% of GDP). However, merchandise trade deficit widened on a quarter-on-quarter (Q-o-Q) basis on account of larger decline in merchandise exports (7.3%) than merchandise imports (4.5%). While the oil imports declined to USD 20.2 billion (from USD 26.8 billion inQ3FY14), gold imports rose sharply to USD 11.07 billion from USD 3.2 billion in Q3FY14. But going forward since oil has shown some impulse, it may have some bearing on the CAD data for Q4FY15 although the rupee appears resilient.
   
• Fiscal deficit: As far as fiscal consolidation is concerned, the Economic Survey 2014-15 states that the fiscal deficit target envisaged in the Budget 2014-15 will be met. It has also said that India must adhere to the medium-term fiscal deficit target of 3.0% of GDP. For this India needs to move to the golden rule of eliminating revenue deficit and ensure that over the cycle borrowing is only for capital formation, the Economic Survey said. But on optimism it was also mentioned that expenditure control combined with recovering growth and the introduction of the GST will ensure that medium term targets are comfortably met.
   

What to expect?

RBI has suggested that, future policy action would primarily depend on the easing of supply constraints, improved availability of key inputs such as power, land, minerals and infrastructure, continuing progress on high-quality fiscal consolidation, the pass through of past rate cuts into lending rates. The RBI would also be watchful of factors affecting food inflation and thus would track climatic changes and developments in the international environment. Escalating crude oil prices at the international market may result in higher inflation in India. The RBI expects, the response of the Government in sticking to the commonly chalked out inflation targets making efforts to improve supply constraints.

PersonalFN believes, if macro-economic indicators remain favourable and monetary policy stance stays accommodative, long term gilt funds might benefit the most. However, you might be better-off if you prefer flexi debt / dynamic bond funds, provided your time horizon and risk appetite permit you for that.

PersonalFN is of the view that, at present, short term rates are higher than the long term rates. This is partially because of huge expectation built-up at the longer end of the yield curve factoring in monetary policy rate cuts. Given the limitations on probable rate cuts, yield curve may normalise sooner or later.

Do you think it will pay off to increase exposure to G-secs now? Share your views

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