Summary

• The risk of greater than expected rise in fiscal deficit, an acceleration in the pace of inflation and lack of buying by PSU banks pressured up yield on the benchmark 10-year Government of India (GOI) bond until late in March when the government announced a sharp reduction in its overall level of borrowing in FY2019.
• While yields fell towards the month end, their favourable impact on the Fund’s performance was muted by a modest widening of corporate spreads.
• Although portfolio capital flows recovered from net outflows in February to net inflows in March, the amounts were too small to lead to appreciation of INR.Indeed, the rupee depreciated by 12bp due to expectations of worsening current account deficit in the coming months.

Market update - Bond market begins to regain lost ground

The bond market remained lacklustre for most of March due to:

• Rising concerns about the fiscal deficit exceeding its targeted level in the just concluded FY2018 as well as in FY2019.GST collection continues to be muted as the recently released February data shows.The central government collected GST revenues of INR4.1trn in FY2018 since the implementation of the new tax regime in July 2017 compared to the budgeted target of INR4.4trn, implying a potential GST revenue shortfall in FY2018. Central government is targeting GST revenues of INR7.4trn in FY2019 (19% growth in monthly run-rate over FY2018). This may prove to be a tall task.

• The most recent inflation news was positive with the headline figures declining to 4.4% in February from 5.1% in January due to a continuing deflation in food prices.The data, however, did not assuage market’s worries about a rising trend in inflation as the core inflation continued to inch up (ex food and energy).
• Finally, several PSU banks cut their purchases of GOI bonds as their bad debt problems worsened.

The dynamics in the bond markets changed sharply in late March when the government made several surprising adjustments to its borrowing program in FY2019:

• Reduction in borrowing - Gross Market Borrowing for FY2019 cut by INR 500bn to INR 5.55 trn vs budgeted plan for INR 6.06trn and a comparable level of INR 5.88trn in FY2018.
• Sharply lower borrowing in the first half of FY2019 -- gross borrowings from dated securities is pegged at INR 2.88trn (down 22.6% yoy), significantly below market expectations.
• Reduction in the overall duration of bond issuance.
• Plans to issue more Floating Rate Bonds and introduce CPI linked bonds, up to 10% of issuances during the coming fiscal year.
• Finally, the government also floated the idea of raising the FPI limit on investments in GOI bonds in the very near future.

Thanks to these measures, the yield on the benchmark GOI bond initially fell by 30bp in a single trading session on 27 March.  It gave up just about 20% of that gain on March 28.

Performance

Despite the 12bps compression in yield on the benchmark 10-year GOI bond in March, the Fund’s NAV gain in Indian rupee terms was held to 69bps because the spread on the 10-year AAA-rated corporate bonds widened by just under 12bps during the month.  Furthermore, the rupee depreciated some 0.12% against the US dollar, which trimmed the Fund’s USD-denominated NAV gain to 0.57%.

Strategy

The Fund sold one round lot of a NBFC perpetual bond and in late February purchased one round lot of the 8.33% GOI bond maturing in 2026.  This switch helped the Fund’s performance because the GOI bond in question went up in price much more than the NBFC bond it replaced.  We intend to pursue similar trades in an opportunistic fashion.