Summary

• October saw a continuation of selling by Foreign Portfolio Investors (FPIs) on the back of a disruptive combination of global and domestic headwinds. FPIs sold equities worth US$3.7bn and debt worth US$1.3bn, resulting in a deeper depreciation in Indian rupee which is down 1.97% this month.
• While equities clocked heavy losses, the fixed income markets were relatively stable and mixed. Government Bonds registered modest gains, primarily supported by Open Market Operation (OMO) purchases by the Reserve Bank of India (RBI). In contrast, corporate bond recorded a tad higher loss, as ripple effects of loan defaults by Infrastructure Leasing & Financial Services (IL&FS) continue to drive credit fears for Non-Banking Financial Services Companies (NBFCs).
• An even-handed mix of short term relief and an uncertain medium term view, calls for prudence over aggression in our view. We remain committed to preserving capital in the near term.

Market update

October continued to be impacted by headwinds on both global and domestic fronts. Global headwinds came from an increasing rhetoric on trade wars between the two largest economies, heightened geopolitical tensions between Saudi Arabia and the rest of the world after the murder of US resident, Saudi journalist–Jamal Khashoggi as well as tighter monetary policy as the US Federal Reserve (The Fed) maintained a hawkish tone for the medium term.

Domestic headwinds to consumption and investment growth came from a fresh round of credit concerns post the unexpected default by IL&FS. Risk contagion resulting in a severe liquidity tightness for NBFCs, which account for 18% of the overall credit disbursement in the country, also contributed and uncertain oil prices, higher commodity prices and increasing cost of credit have started to hurt both consumer sentiment and companies’ pricing power.

The bond markets had a mixed performance over the month, led by global synchronised slowdown fears and waivers by the US under Iran sanctions to a few large oil importing nations, including India, which led to a meaningful decline in crude prices and assuaged incremental concerns on the trade deficit and inflation. RBI kept the policy rates unchanged, with a tweak in policy stance from neutral to calibrated tightening. However, RBI cut its own inflation range projections for the remainder of the fiscal year by 30-80bps, which was interpreted positively. RBI injected durable liquidity by buying government bonds worth INR360bn through OMO. Close to month end RBI announced a further liquidity injection of INR400bn. Despite this, corporate bond spreads moved asynchronously as the liquidity situation remained tight, especially for NBFCs, with high reliance on short term wholesale debt.

Performance

On a point-to-point basis, the benchmark five-year yield on Government bonds fell by 27bps from 8.07% to 7.81%. Whereas the spread on five year AAA corporate bonds widened from 60bps to 86bps. This led to a modest 0.71% gain in net asset value (NAV) in Indian rupee terms. With respect to currencies, a 1.97% Indian rupee decline versus the US dollar yielded a NAV loss of 1.26% in US dollar terms. Year-to-date, the Fund’s NAV is up 1.62% in Indian rupee terms and down 11.82% in US dollar terms when adjusted for the 13.44% Indian rupee depreciation.

Strategy

We see a mixed outlook near term, with higher odds of a relief bounce led by a sharp depreciation in the Indian rupee against long-term averages of 3-4% depreciation. In addition to a comfortable CPI inflation trajectory with a slow and steady pick up in GST revenues. There is also consistency in fiscal discipline and stability in policy rates backed by macro-economic factors.

The medium term outlook remains cloudier on account of upside risks to crude prices, unpredictability of trade outcome between the US and China, and steadfastness by The Fed on future rate hikes over the next 12 months. There is also nervousness ahead of state elections in December and general elections in May. IL&FS’s ripple effects on the financial sector have led to an increasing public spat between the executive and regulatory branches of government.

We continue to stick to a prudent strategy with low duration bonds, with an eye to react in a nimble and decisive fashion when convinced that the fog of macro risks is lifting.