Summary

• Global risk markets continued their upward trend for the fourth consecutive month led by a turn of the tide on two important global issues – the UK Election and the US-China trade war
• India participates in the global buoyancy, but is restrained by increasing growth concerns and surprisingly sticky inflation in short term
• Attractive real yields, against a backdrop of supportive monetary policy, proactive and conscientious government, drive our positive view on the total return opportunity in Indian debt markets.

Performance

The Fund was up INR 0.07% in November.  A 0.51% appreciation in USD-INR drove the USD performance to 0.58%. Fund performance was aided by high interest accruals in corporate bonds offset by principal losses as yields backed up. The biggest gains were registered in Mahindra & Mahindra Financial Services, Cholamandalam Investment & Finance Company, Reliance Jamnagar Utility & Power Ltd and IGB 2039. The biggest losses were registered in Yes Bank, Shriram Transport Finance, Bajaj Finance and Power Grid Corporation. 

Market update

Global risk markets continued their upward trend for the fourth consecutive month and emerging markets finally outperformed. December’s move can be attributed to the apparently positive resolutions of two global issues which overhung global markets for 18 months. On 13 December, a decisive general election victory for UK Prime Minister Boris Johnson halted the uncertainty around Brexit, making way for a more predictable political landscape to negotiate Brexit conditions and a potential improvement in European business conditions. This coincided with the US and China outlining the first phase of a deal to end their trade war, with the US easing tariffs on Chinese goods and seeking structural reforms to China’s economic and trade regime in intellectual property, technology transfer, financial services, and foreign exchange. The UK election and US-China events occurred in an environment of stable policy rates and accommodative monetary policy provided by prominent central banks, further fueling the rally. The Morgan Stanley Capital International (MSCI) Emerging Markets Index returned 7.2% while MSCI USA Index and MSCI Europe Index rose 2.9% and 2.0% respectively. Currency and commodities also participated with the JP Morgan Emerging Market Currency Index and the Rogers International Commodity Index rising 2.7% and 5.5% respectively.

Indian markets also participated, but were restrained by growth concerns. As per the Central l Statistical Office, India’s current fiscal year real GDP growth is likely to decelerate to 5%, impacted by weakening private consumption growth to 5.8%, only partially offset by government consumption growth at 10.5%. This capped Nifty 50 gains at INR 0.9% and Nifty 500 gains at INR 0.6%. Bond markets were flat with CRISIL Composite Bond Fund Index registering a modest INR 0.1% gain, led by sizeable yields in debt markets and offset by meaningful retracements in G-Secs. Inflation also proved to be an impediment as November CPI surprised to the upside at 5.5%, led by higher than expected food inflation at 10.0% and a surprising uptick in core inflation at 3.7%. This occurred despite sluggish economic activity, with IIP contraction at 3.8%. Headline CPI Inflation overshot the RBI target of 4% for the second consecutive time and prompted the Monetary Policy Committee to keep policy rate on hold in its December policy meeting.

The RBI disappointed with its pause in policy rate cuts but took steps to acknowledge the challenges to monetary policy transmission given the steep yield curve. The simultaneous purchase and sale of government securities, a tool closely resembling the ‘Operation Twist’ by the US Federal Reserve was announced and two rounds have been conducted thus far. Sticky inflation also flattened the yield curve as yields on 2-year, 5-year, 10-year G-Secs backed up by 43 bps, 28 and 9 bps respectively. The yields on Corporate Bonds backed up modestly, tightening spreads by 9 bps for 5-year AAA and AA rated corporates.

RBI has cut policy rates by 135 bps thus far and remains supportive of lower rates and has stressed the dominant role of fiscal policy in reviving growth. Government maintained the reform momentum and we highlight a few incremental steps taken in December;

• The government approved the creation and launch of a Bharat Bond Exchange Traded Fund (ETF) with a maturity series of 3 and 10 years, to create an additional source of funding for government ran organisations. It would consist of only AAA rated bonds and would be the first corporate Bond ETF in the country
• The government extended the partial credit guarantee scheme to include NBFCs and HFCs papers rated up to BBB+. The government’s partial credit guarantee scheme covers assets of up to Rs1 tn, with the amount of overall guarantee being limited to the first loss of up to 10% of fair value of assets
• The government-led task force compiled a national infrastructure pipeline with capital spending of Rs 102 trillion on infrastructure projects from FY2020-25 versus total spending of Rs 51 trillion over the past six years. The vision encompasses 24*7 affordable power with a focus on renewable energy, convenient and efficient transportation and logistics, housing and water supply for all, farmer focus - increased irrigation spending, storage, processing and marketing infra and a stronger social infrastructure and digital infrastructure. Projects worth INR 43 trillion are now under implementation and another INR 33 trillion are in conceptualization stage. The funding share of centre and state stands at 39% each, with the balance 22% envisaged from the private sector, increased to 30% by 2025. A separate agency for project monitoring and expediting work execution will also be created.

INR gained 0.5% against the USD, reflecting the global favorable trends for emerging markets. External position remains supported by lower non-oil imports and strength in service exports and capital transfers. Gains were restricted in December on account of softening in FPI inflows of $0.86 billion in equities and $0.76 billion outflow from debt. Crude strength was an incremental currency drag.

Outlook

High-frequency data suggests that growth may have bottomed out, but the recovery is likely to be slow as India’s growth engine has been slowed down by several issues. We are encouraged by the multi-pronged, proactive and conscientious approach taken by the government over the last five months to extinguish risks and seed long term growth drivers of the economy. Inflation, especially food, will begin to ease this quarter with the arrival of the Kharif produce and governmental supply-side measures. 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. Despite the modest flattening in December, the yield curve remains attractive, offering potential for a long duration rally and a double-digit return opportunity. Credit spreads remain close to their widest levels in last 10 years. These spreads are likely to normalize with a high focus on growth revival by the monetary, fiscal and regulatory bodies of government. The Fund is poised to take advantage of these benign bond market conditions in the coming months.