The steep yield curve and wide credit spreads paired with dovish monetary policy and proactive and conscientious government, drive our positive view on the total return opportunity in Indian debt markets.
Global risk markets continued trending upward in November with developed nations taking the lead. This move is largely supported by accommodative monetary policy on muted inflation and a subdued growth outlook on account of prolonged US-China trade and technology tensions and uncertainty on Brexit. The risk market performance skews towards developed nations and has been supported by modest beats on growth expectations for the US, Japan and Europe. The emerging markets and developing economy group have seen downward revisions across all major regions and countries including India. This performance was also impacted by strong gains in US dollar and weakness in Commodities. Global bond markets backed up modestly after sharp gains in the previous quarter and no consequential trend or signals in near term.
Against this backdrop, Indian markets held up on quite well as the NIFTY 50 registered 1.5% gains. Bond market performance was mixed. Long duration G-secs have remained largely flat for four months despite numerous policy rate cuts during this period. The outcome is yield curve steepening to the higher end of historic band with 9-year and 13-year G-Secs at 160bps and 190 bps spread over the policy rate. Credit spreads are in the upper range of historic bands as well, despite modest retracements over the past two months. Aggressive government measures and a larger risk appetite helped to narrow 5-year AAA and AA rated corporates credit spreads by 14bps and 24 bps respectively; however spreads for A rated and below continue to remain extremely wide. Foreign Portfolio Investor flows echoed these trends with US$3.2bn inflow into equities and US$0.5b outflow from debt. These flows helped the Indian Rupee counter the weakness registered in the JPM Emerging Markets Currency index but were not enough to overcome the US dollar strength resulting in a 1.1% INR depreciation against US dollar.
Proactive, multi-pronged government reform measures aimed at reviving credit markets continued in November. A first step was a commitment of Rs100 billion to establish a Rs250 billion real estate fund to provide last mile funding to stranded housing projects. In a highly notable departure from earlier announcements, the fund has now extended the scope of credit to projects that have been considered non-performing or are under restructuring.
Mid-month, the Supreme Court delivered an important ruling on the Insolvency and Bankruptcy Code (IBC) bankruptcy process concerning the long overdue Essar Steel case, by upholding the supremacy of decisions taken by the Committee of Creditors and restraining the court’s role to that of an observer of the process. The ruling could expedite the settlement process and permit a bad loan sell down from banks to distressed asset funds. Additionally, the Ministry of Corporate Affairs notified NBFC of rules for insolvency and liquidation proceedings under the IBC mechanism with a key role for the RBI. An abrupt settlement of long overdue litigation between wireless telecom companies and the Department of Telecom quickly followed and meant heavy penalties for telecom companies. The three wireless companies took steep price increases and paved the way for balance sheet repair.
The Union Cabinet took two important steps this month by approving disinvestment in five central public sector enterprises - Bharat Petroleum Corporation, Shipping Corporation, Container Corporation of India Ltd, Tehri Hydro Development Corporation (THDC India Ltd.) and North Eastern Electric Power Corporation Limited, as part of a governmental objective to raise INR 1 trillion in non-tax revenues to relieve fiscal pressures. The cabinet approved the Industrial Relations Code, 2019 to speed labor reforms, with an intent to consolidate and amend laws relating to trade unions, conditions of employment in industrial undertaking, investigation and settlement of industrial disputes and enable companies to hire workers on fixed-term contracts of any duration.
Economic data was backward looking and disappointed relative to expectations. 2QFY20 real GDP growth moderated sharply from 5% in 1Q to 4.5%. 2QFY20 nominal GDP growth also slowed from 8.0% in 1Q to 6.1%, exacerbating the challenged state of government finances. September IIP growth slumped from -1.4% in August to -4.3%. October manufacturing PMI fell from 51.4 in September to 50.6. October CPI inflation rose from 4.0% in September to 4.6%. The increase was led by higher food inflation and is likely transient. Core inflation for October moderated from 4.2% in September to 3.3%, aptly reflecting subdued economic activity.
The Fund was up 0.58% in INR terms in November. The 1.12% depreciation in USD-INR drove the USD performance to negative 0.56%. Fund performance was aided by high interest accruals in corporate bonds and modest tightening in most corporate credit spreads. However, increases in credit spreads for Indiabulls Housing Finance and Cholamandalam Investment & Finance restricted the overall gains to the overall distribution yield.
India’s growth engine has been slowed by a mix of small issues, but we are encouraged by the multi-pronged, proactive and conscientious approach taken by the government over the last five months. These measures will surely ignite a growth recovery, albeit gradually. In the interim, we expect softer inflation-growth dynamics to continue into 2020.
This economic backdrop keeps us constructive on debt markets as both yields and spreads are expected to rally and drive positive returns. The yield curve remains steep, offering potential for a long duration rally and a double-digit return opportunity. The Fund has a little over one-third of its book in long duration G-Secs to capitalize on this opportunity. Credit spreads remain closer to their widest levels in last 10 years and that is on top of a steep yield curve. These steep spreads are likely to normalize with a high focus on growth revival by monetary, fiscal and regulatory bodies of government. The Fund is poised to take advantage of these benign bond market conditions in the coming months.
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