Summary

• Yield on the benchmark ten-year Government of India (GOI) bond went up by 9bps from the low immediately following the August 2^nd decision by the Reserve Bank of India (RBI) to cut the policy interest rate by 25bps.
• Acceleration in July’s retail and wholesale inflation due to rising food prices fueled expectations of additional pick-up in inflation in the months to come.  This signaled a limited scope for further policy rate reductions, thereby driving yield higher.
• Corporate bond spreads, however, narrowed by 19bps indicating continuing robust demand from the institutional segment.  Reflecting this strong demand, foreign portfolio investors put in US$2.4bn in India’s debt markets during August. 

Market update - Hardening yields

Several factors contributed to a modest increase in yield on the benchmark 10-year GOI bond in August:

• Consumer price inflation (CPI) accelerated to 2.4% year on year (YOY) after three months of deceleration. The acceleration was largely driven by the pick-up in food prices and housing, the latter due to the implementation of higher housing rent allowances for central government employees. 
• The wholesale price index (WPI) increased to 1.9% YOY in July from June's trough of 0.9%. The acceleration was primarily driven by pick-up in food and commodity prices. Non-food, non-fuel inflation rose only marginally to 1.7% in July from 1.6% in the month before. 
• The latest reports on the progress of monsoon rains have been a bit disappointing, raising concerns of additional acceleration in food prices. Season-to-date (1 June to 31 August) rainfall is now 4% below the long-term average level.  Deficient rains in northwest, central and southern India is curtailing acreage under pulses, oilseeds, rice and coarse cereals.

Against this background of potentially rising inflation came the release of decelerating GDP growth at month-end.  In the April-June quarter of the current fiscal year, GDP growth slowed much more than consensus market expectations to 5.7% YOY.  The consensus estimate of growth was as high as 6.5%. Indeed, growth was lower than 6.1% in the final quarter of the last fiscal year ended March 2017.  While investment picked up ever so slightly to 1.6% from -2.1% in the previous quarter, private consumption slowed further to 6.7% from 7.3%.  The lingering effects of demonetisation and the implementation of the GST may have had adverse impact on consumption.  Unless this growth recovers, however, there is unlikely to be a meaningful increase in investment.  As a result, growth is likely to stay subdued for at least one more quarter.

While the slowdown in growth will increase pressure on the RBI to cut policy rates in the coming months, the expected rise in both CPI & WPI may limit the scope for such action.  As such, the market will likely wait for more information on details on growth and inflation trajectory before building up heavy positions.

The Fund benefitted from the 19bps compression in corporate spreads and 0.3% appreciation of the Indian rupee against the US dollar during August.

Prior to the negative news on GDP growth, the Fund had raised the share of corporate bonds in its total holdings to 45% from 40% in the month before while keeping the portfolio’s duration flat at 4.2 years.  This shift towards corporate bonds has served us well.  No significant changes in the portfolio’s composition are contemplated given the current uncertainty on RBI’s rate policy.