Indian govt debt preferable to corp bonds given narrow spread - IDFC AMC's Kaul

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By Dharamraj Dhutia

MUMBAI (Reuters) - The supply of Indian corporate bonds could rise going ahead, but their narrow spread with government bond yields currently makes them a comparatively unattractive investment, a fund manager from IDFC Asset Management Co said on Friday.

"We believe that while the absolute levels offer value, the current narrow spreads still favour government bonds vis-à-vis corporate bonds," said Gautam Kaul, senior fund manager, fixed income at IDFC AMC.

"Corporate bonds will become more attractive once the spread is closer to long-term averages."

Historically, the spread between AAA-rated corporate bond yields and government bond yields has been in a range of 70 basis points (bps) to 80 bps. But that has turned nearly flat in the last few weeks as government bond yields tumbled.

Still, if investors want to go for corporate bonds, then the three- to five-year part of the curve offers the most value currently, Kaul said.

The supply of corporate papers has been lower so far this year as the Reserve Bank of India's aggressive interest rate hikes sent yields rocketing in the initial part of the year.

Kaul expects supply to rise down the line as economic activity has returned.

"It is reasonable to assume that the trend in higher credit demand should start reflecting in the corporate bond supply as well."

Typically, corporates have to pay higher rates than the government to compensate for the greater perceived risk. But top-rated companies have been enjoying a much lower spread than historical standards of late, which makes such debt a less rewarding and riskier bet.

For example, AAA-rated state-run Housing and Urban Development Corp issued more-than-three-year bonds at a 7.54% coupon earlier this week.

In comparison, the benchmark three-year government bond yield ended at 7.42% on a semi-annual basis on Thursday.

Government bond yields crashed on Friday, dropping by 10-15 bps across the curve and tracking a similar move in U.S. yields after inflation in the world's largest economy eased in October.

Cooling inflation could lead the Federal Reserve to go slow on rate hikes, which could prompt the RBI to follow suit.

Kaul expects the RBI's policy repo rate to top out in the 6.25%-6.50% zone, after a hike of 25 bps to 35 bps in December.

(Reporting by Dharamraj Dhutia; Editing by Savio D'Souza)