Seeking stability in an uncertain world
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Fixed income funds can provide stability to an investor's core portfolio and potentially deliver inflation-adjusted returns
The global economy had encountered fresh headwinds in 2012 and growth (especially in the developed world) slowed. Given the already high sovereign debt levels, there was limited room on the fiscal front and hence, the new stimulus had to come from central banks in the form of further quantitative easing and other unorthodox measures. This helped global bond markets extend gains from 2011, despite concerns over recent months about a potential spike in real asset prices due to the easing. In the case of Emerging Markets, the recent easing in commodity/energy prices has provided more headroom for monetary easing and EM central banks are looking to provide growth support.
The RBI is faced with unique challenges— while growth has been slowing down a combination of global factors, policy perception issues and high rates, inflation has remained sticky and fiscal deficit has been high. As a result, RBI has been maintaining a cautious stance and had announced a higher than expected rate cut in the middle of the year. Over the last few quarters, the central bank has repeatedly made clear its concerns about inflation and the lack of progress on subsidies and fiscal consolidation. The government's recent measures have addressed some of these concerns through new reforms (diesel price hike, relief to the power sector and a fiscal consolidation roadmap). However, the RBI feels that the positive impact of these steps will take some time to percolate and has maintained its focus on inflation/deficits. It has also rightly pointed out that interest rate cuts are not a panacea for all the problems being faced by the economy.
At the same time, it should be noted that borrowing costs have already come down from the peaks witnessed earlier in the year —(3 month CP/CD rates have declined by around 230/240 bps since March 2012. The central bank has been quite actively managing the liquidity situation—the cash reserve and statutory liquidity requirements for banks have been lowered by 175 bps and 100 bps respectively in 2012. These measures, along with the 50 bps cut in the repo rate in Q2, have helped borrowing costs move down—the quantum of decline in yields has been relatively higher at the short-end (1-year), when compared with the longer-end of the curve (10-year). Corporate bond spreads over gilts have also contracted quite a bit— down 53 bps for 5-year AAA corporate bonds since March 2012.