Summary

• Although headline consumer price inflation held steady at 3.3% year-on-year (YOY) in September, yield on the benchmark ten-year Government of India (GOI) bond went up by 20bps in October.
• Hawkish policy stance of the Reserve Bank of India (RBI) and the government’s announcement of a massive bank recapitalisation program for state-owned banks, to be funded predominantly by issuing recapitalisation bonds, dampened bond market sentiment.
• The Fund gained 0.8% in October despite the rise in yields on GOI bonds and flat corporate spreads due to robust foreign capital inflows in debt markets which led to an 85bps appreciation of India rupee against the US dollar.

Market update - Rising yields

Two factors contributed to the 20bps rise in the benchmark yield in October – the cautious tone of RBI’s monetary policy and the potential surge in bond issuances to support the proposed recapitalisation of state-owned banks.

The October Monetary Policy Committee (MPC) meeting suggested a reduction in the probability of a rate cut in December. Firstly, the MPC raised its consumer price inflation projection for the second half of fiscal 2018.  It stated that various factors including potential fiscal slippages could pose upside risks to inflation. Second, the RBI also seemed to suggest that the slowdown in GDP growth is transient and hence further rate action will be unnecessary.  

In late October, the government announced a recapitalisation plan for state-owned banks amounting to INR2.1trn (US$32bn). This will comprise of a front-loaded capital infusion of INR1.35trn to be funded by issuing recapitalisation bonds, and INR760bn of capital infusion from budgetary support and proposed capital raisings by state-owned banks. The details of the recapitalisation programme are not yet known. However, bond markets have viewed the additional bond issuance negatively. Yields have already been under pressure in recent months due to the heavy supply of state-government bonds and frequent sale of bonds by RBI via open market operations (OMOs). Hence, there is limited appetite for any additional supply of bonds, especially the less liquid recapitalisation bonds.  The government can soften their negative market impact, however, by encouraging cash-rich public sector companies to buy and hold bonds to maturity, by requiring banks to hold them to maturity, and by reducing the size and frequency of liquidity management OMOs.

Along with bank recapitalisation, the government also announced in late October a huge road sector investment program totaling INR6.3trn (upwards of US$100bn) over the next five years with potential road construction of 16,700 kilometres per year. This is a very positive measure for creating jobs and improving growth.

 

Strategy

Unless corporate bond spreads decline sharply, the Fund will continue to sell GOI bonds in the portfolio and purchase corporate bonds to pick up spreads on corporate bonds of around 50 to 70bps on AAA-rated and 120 to 140bps on AA-rated bonds.