Some parts of the economy clearly looking up: Amit Tripathi, Reliance Capital

Mythili Bhusnurmath, Consulting Editor, ET Now and Amit Tripathi, CIO-Income Investments, Reliance Capital discuss the latest IIP numbers. Excerpts:

ET Now: Many say that the latest IIP numbers don't reflect the actual situation. Why is the consumer durables data negative despite companies reporting very positive sales? For that matter, why did manufacturing numbers come in so much below analysts' expectations?
Amit Tripathi: When it comes to IIP, one has to look at a lot of high-frequency indicators. The economy really has two levels — that's how I would want to put it.

One part of the economy is doing reasonably well — urban consumption and the like. Certain other parts are going slower. Some components of the IIP are nuanced — they've been moving both ways. That warrants a closer look at the high-frequency indicators that I mentioned.

There are clear signs that some parts of the economy are clearly looking up. That is reason enough to be positive, if not outright bullish.

Mythili Bhusnurmath: One needs to stop comparing IIP with GVA-based GDP. The first one is on the basis of volumes, while the second one is based on the value added. One should also not look at IIP in numbers alone; the trend is important too.

Whatever deficiencies or inconsistencies there are in IIP vis-à-vis GDP, they are consistent within the IIP series. So if you look at IIP over a period of time, then it does seem to suggest that despite high hopes recovery is certainly not happening.

IIP was barely positive at 2% in February. Then it became just 0.1% in March. And now, we have it slipping into negative territory in April. So the overall trend within the IIP gives us a certain amount of disquiet.

So, you still have reason to hope? Or would you think that we are still not out of the woods?
Amit Tripathi: From my perspective, consumer non-durables and capex-oriented sectors are showing much more volatility. Growth has not been as expected.

But there area certain other areas that have shaped up well. From a credit allocation side, we look at those sectors more closely.

I believe that other than the IIP, there a reasonable number of other high-frequency indicators. Auto numbers, for example, continue to behave well. Urban consumption numbers continue to come up well. So there are certainly better performing pockets in the economy.

As we go along and as commodity prices start stabilising, some part of the so-called laggards within the IIP will also start basing out. We may not get very high numbers for some time, but we will definitely not end up in the negative territory.

Mythili Bhusnurmath: India's real problem is supply constraint. Unless investment happens we are again going to hit the supply barrier, which could make the RBI turn on the screws aggressively. What is the sustainable way out?
Amit Tripathi: If you are looking at it from an inflation perspective, we will then have to distinguish between the manufacturing side and the services side. In manufacturing we have quite a bit of excess capacity. If demand were to pick up, we won't see any over-heating in that space because of this built-in excess capacity.

This could also be because of the fact that aggregate demand has come down in the last few years, which in itself has created that excess without any incremental capex happening.

On the services side, we are seeing more capacity enhancements happening than on the manufacturing side. That is also the area of the economy which is doing relatively better in the last few years.

In totality, I would presume that over the next 12-24 months demand-led inflation has much less chances of happening. Even if demand were to pick up from here — especially on the industry side — the spare capacities would take care of demand for the next 12-24 months.

However, if demand is much robust and it continues beyond that period, then the issue of capacity constraints will come into the picture.

ET Now: Where do you see the rate cycle in the next 12 months? And how do you think the money markets would perform in the next 12 months amid all this global uncertainty?
Amit Tripathi: The biggest game changer in the last 12 months has been RBHI's April policy, which notified the shift from deficit liquidity neutral liquidity. We have said many times that we are going to see more and more focus on transmission now.

The RBI has cut rates by 150 bps. It is very important to understand that they still continue to remain accommodative. They are actively looking at any kind of space getting created for them to cut rates further. So one should not think rate cuts are over. The RBI is looking for more elbow space.

In our view, potential rate cuts range between 25 and 50 bps for the remaining part of this financial year. But I reiterate that the focus is more on transmission, on providing liquidity.

The OMOs that the RBI has done so far clearly shows that it wants to bring the system closer to neutral in terms of liquidity. It has big ramification for money markets in general, and for various products in particular. You will definitely see a further steepening of the curve compared to what we saw in the last 12-18 months. Assets with tenure of one to five years could fall further meaningfully from the current levels. Longer tenure yields will come down too, but they won't match the fall in basis points.

The curve will steepen. The fallout essentially is that all products or assets that function within this segment would tend to do well. So from a portfolio perspective, we are clearly positioning ourselves for that steepening.

Products that will do well in such an environment will include things like Reliance short-term bond fund, private sector credit-focused funds such as regular savings fund, corporate bond fund, etc.

For investors who would want to play the duration game should best go for products such as the dynamic bond fund.

So like I said, the focus on transmission and better liquidity could be a game-changer for the debt markets. A lot of additional returns could accrue because of the steepening of the yield curve, and not necessarily because of incremental rate cuts.

Mythili Bhusnurmath: You have entirely omitted the 800-pound gorilla — Janet Yellen. What she does going forward is critical to what Rajan can do. If Yellen raises rates, there won't be much Rajan can cut. So, is the party for debt funds largly over, and is equity really the story from here on?

Amit Tripathi: Indian interest rate is always a domestic story. It's the Indian macros which determine how rates would behave. During 2010-13 all the globe cut rates but India didn't, because our domestic macros were not in the best of shapes.

Now, Indian macros — inflation, fiscals — have come a long way from that situation. If domestic macros continue to remain the way they have for the last 18-24 months, we are very likely to see rates coming down further.

There will very likely be additional volatility in global markets around the Fed event. But even if Fed raises rates by 25-50 bps over the next 6-12 months, it would not necessarily impact Indian rates. There is a very clear opportunity because of monetary transmission at the shorter end of the yield curve.

I believe that the RBI would remain accommodative and constructive as long as Indian macros keep behaving well. And in all probabililty, our macros will be good over the next 6-12 months.

The Fed, for its part, would raise rates only gradually, if at all. A 25-bps rise in US rates spread over 6-12 months will in no way make Indian markets behave negatively.

Mythili Bhusnurmath: But India is not a consistent economy. Every time we look like we are going to do well, suddenly something happens and we falter again. Domestic investors are currently gung-ho about the MF industry. But if markets turn they could leave en masse. They have done it before, have they not?
Amit Tripathi: We are seeing more and more investors coming into the MF industry not only on the equity side but also on the debt side. We now have more sticky money, more retail participation coming in. Their holding periods have also become fairly long-term.

From that perspective, we believe this money is much more stable. Systemic liquidity conditions are getting better. Investment opportunities will only increase going forward.

MFs are increasingly being seen as a more efficient vehicle for putting savings to work, even on the debt side. For that reason, I believe retail and HNI investors would find MFs a more constructive way of investing into the debt markets, and we will continue to see flows come in.

I believe this industry has come of age in terms of flows. We will likely see — on a net basis — more and more money coming through the MF route, particularly into the debt markets.