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India Fixed Income Opportunities Fund - March 2018

Fixed income markets hit by budget and policy announcements.


  • Debt markets reacted negatively to the budget pronouncements on 1 February 2018 which revealed a slippage in commitment to fiscal discipline. Additionally, the announcement of cost-plus formula in setting minimum support prices (MSPs) of cereals led to fears of rising inflation.

  • While yields rose, their adverse impact on the Fund’s performance was mitigated by tighter corporate spreads.

  • The unexpected introduction of a 10% tax on long-term capital gains caused foreign portfolio investors (FPIs) to withdraw US$1.93bn from the equity markets. FPIs also pulled US$421m from the debt markets. The end result was a sharp 2.37% depreciation of the Indian rupee against the US dollar.

Market update - Bond market woes persist

The Union Budget, Reserve Bank of India (RBI) monetary policy, inflation data and the US Federal Reserve had heavy adverse impact on sentiment in the Indian debt market throughout last month:

  • In the Union Budget unveiled on 1 February, Finance Minister Arun Jaitley targeted a fiscal deficit of 3.5% and 3.3% of GDP for FY2018 and FY2019, thereby exceeding the earlier promise of holding their levels to 3.2% and 3.0% of GDP, respectively. The fiscal “miss” in FY2018, ending on 31 March, is due to higher spending rather than a revenue shortfall. This confirmed the market’s belief that the government has started to gear up for the 2019 general election. A number of state assembly elections are scheduled for this year. If the results signal an erosion in the support for the ruling Bharatiya Janata Party, additional fiscal slippage cannot be ruled out.

  • The government also announced its intention to set MSPs for cereals at one and one-half times their production cost, which led to fears of a rising inflation trajectory in an already worrisome environment.

  • As expected, the RBI held policy rate unchanged at 6.0% and retained the “neutral” policy stance in its sixth bi-monthly review. Its commentary and minutes failed to provide guidance on the course of monetary policy in the coming months, creating uncertainty for market participants.

  • While the inflation data was in line with expectations – January 2018 CPI stood at 5.07% compared to 5.21% in December 2017 – markets took note of the fact that the impact of deflationary bias in the Consumer Price Index (CPI) food basket was offset by persistent rising pressures emanating from the non-food (especially housing) components of CPI.

  • The passage of the tax reform and reduction bill in the United States raised the risk of the US Federal Reserve implementing steeper rate hikes than previously contemplated because the fiscal stimulus is being provided when the labour markets are already tight and the economy is operating at or close to its potential.

The Indian rupee also depreciated 2.37% against the US dollar.  In addition to capital outflows from India’s debt and particularly equity markets – the latter due to a new 10% tax on long-term capital gains – the worsening trade deficit exerted additional pressure on the rupee. Trade deficit burgeoned to a 56-month high of US$16bn in January 2018 versus US$15bn in December 2017 and just US$9.9bn in January 2017. Exports underperformed but imports rose.

Strategy and outlook

While the bond markets face headwinds in the short run, there is little doubt that inflation would fall in the second half of 2018 provided the monsoon rains are normal. Bond yields will then begin to recede from their current high level of 7.7% 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. Indeed, the Fund already replaced two corporate bonds in the portfolio with the 8.33% GOI bond due 2026. We intend to pursue more such trades in an opportunistic fashion.