Summary

• Indian equities continued to move higher over January with the large cap outperforming mid and small cap indices. Worries over the annual budget on 1 February prompted domestic investors into some profit taking of mid and small cap stocks, whilst some decent results and continued foreign flow aided the larger counters.
• The Q4 2017 result season has started well, with numbers exceeding expectations so far. If the results continue to beat analysts’ forecasts this will likely be the best quarter for some time.
• On 1 February the government delivered its annual budget. Worries over fiscal profligacy and populism were largely allayed, although the focus on rural India indicates the mind of government is turning to the 2019 national election. The biggest announcement was an ambitious healthcare insurance scheme covering 500 million beneficiaries.

Market update

Sentiment in the Indian debt market remained bearish throughout last month:

• The government announced additional borrowing of nearly 730bn rupee (~0.5% of GDP) for the last quarter of the current fiscal year (FY) which concludes at of the end of March 2018. This announcement stoked fears of considerable fiscal slippage from the targeted 3.2% of GDP for FY2018.
• The markets priced in additional fiscal slippage in FY2019 with analysts projecting a deficit of 3.2% of GDP versus 3.0% of GDP promised in the fiscal consolidation glide path. The central force driving this projection was the outcome in the Gujarat assembly elections late last year. Although the ruling party (BJP) managed to win in Gujarat, it lost vote share in the rural regions of the state. This led to a consensus among investors that the government’s focus would shift away from fiscal discipline towards inflationary spending in rural areas with the aim of winning various state elections in 2018 and the general election in 2019.
• Persistent increase in retail inflation – consumer price inflation in December increased to 5.2% vs 4.9% in November – also nudged bond yields higher. Apart from unfavorable base, rise in food, fuel and housing components contributed to the uptick in headline inflation.
• Risks of rising global crude oil prices fed into higher headline inflation expectations further contributing to higher yields.

Trading activity in the bond market remained lackluster throughout the month. 

Performance

Despite rising yields/falling bond prices in rupee terms, the Fund gained 0.82% in US dollar terms in January 2018. The Fund’s performance was helped by a 13bp tightening in corporate spreads and a 35bp appreciation of rupee against the US dollar.

Strategy

On 1 February 2018, Finance Minister Arun Jaitley presented the Union budget for FY2019, the government’s last full budget before the 2019 general elections. The budget signaled a shift in the glide path for fiscal consolidation, targeting a fiscal deficit of 3.5% and 3.3% for FY2018 and FY2019, respectively. The government also announced its intention to set Minimum Support Prices (MSPs) for cereals at one and one-half times of their production cost. These budget features contributed to higher inflationary expectations. While we believe that the debt market’s immediate knee-jerk reaction to the budget was overly negative, there is little doubt that yields would stay elevated in the short run. But as inflation begins to moderate by the mid-year (provided the monsoon rains are predicted to be normal), bond yields will begin to recede from their current high level of 7.6% on the benchmark 10-year GOI bond. That would make investment in long duration GOI bonds much more attractive than it has been for a long time.  Accordingly, the Fund intends to replace its exposure to corporate bonds with that to long duration GOI bonds.