- Continued escalation in COVID-19 infections and quarantines drag economic sentiment and activity. This drives the world economy closer to a contraction and trigger precipitous losses in global risk markets and a sharp rally in safer asset classes
- Indian markets mirror global trends, withstanding the weak macro headlines supported by a fiscally neutral budget and a supportive monetary policy in the first half; succumb to a global risk-off jolt, and a sharp rally in debt markets in the second half of the month
- 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.
The Fund was up INR 1.99% in February, however a 1.12% USD-INR depreciation capped the performance to 0.84% USD gain. This performance was led by a combination of high interest accruals and yields rally. Credit spreads expanded modestly reflecting the trend in risk markets and partly offset sharp gains in G-secs. This resulted in total return gains in excess of annual distribution yield at 7.0%.
February saw steep losses in growth asset classes and a sharp spike in volatility across the globe. The sole catalyst was the spread of the COVID-19 virus beyond China’s borders. After weeks of under reaction, quarantines and heightened global anxiety is now exacerbated via a hyper-connected social media world and ultra-competitive 24-7 global news media. The outcome is a severe hit to economic sentiment, declining real business activity, global supply chain disruptions, slowing travel and widespread public and private event cancellations. Governments and central banks swiftly moved to limit real economic damage, however, given the existential concerns surrounding a global pandemic, early fiscal and monetary stimuli will have limited impact until the peak curve in infections has passed. For February, the MSCI USA, Europe and Emerging Markets Indices fell by 8.3%, 8.7% and 5.3% respectively. Currency and commodities followed suit, with the JP Morgan Emerging Market Currency Index and the Rogers International Commodity Index dropping by 2.6% and 7.1% respectively. Safer assets concurrently rallied with US two year treasuries rallying from 1.31% to 0.91% and US ten year treasuries rallying from 1.51% to 1.15%. Gold rallied 4.3% intra-month to its highest level in the current five year rally but relinquished the gains to close flat, indicating some indecisiveness amidst the high volatility. S&P VIX levels shot beyond the normalized band of 12-20% to 3-sigma levels at 40-50%.
Indian markets mirrored the global markets with additional idiosyncratic developments on domestic front. The month started on the cautious note ahead of the year’s most important annual Union Budget event on February 1 which maintained fiscal prudence and took steps to attract foreign portfolio flows. The RBI policy meeting on Feb 5 maintained status quo on policy rates, but emphasized on on transmission and greater visibility on comfortable liquidity conditions. The system liquidity surplus stands elevated at historically high levels of INR 3.4 trillion.
Markets saw a few negative headlines mid-month with the Supreme Court cracking hard on telecom companies and government officials for not complying with its order to deposit the statutory dues by Jan 23. Moody’s slashed India’s GDP growth forecast for CY2020 from 6.6% to 5.4%. January CPI readings inched up further to 7.59%, primarily led by sticky food price inflation. December IIP contracted by 0.3%, on adverse base effects and manufacturing sector contraction. Markets withstood these weak headlines before yielding to the COVID-19 led risk-off in growth markets and rally in debt markets. The NIFTY-50 and Nifty-500 fell by 6.4% and 6.3% respectively with all sector indices registering losses. G-Secs yields on 2-year and 10-year treasuries rallied by 47bps and 34 bps respectively. Credit spreads expanded modestly reflecting the trend in risk markets and partly offsetting sharp G-sec gains. The INR weakened by 1.14% against USD despite supportive capital flows and was dragged by emerging market trends with 2.6% loss in JP Morgan Emerging Market Currency Index.
India’s growth engine has been slowed down by a mix of many small and big issues over the last decade. In response, we are encouraged by the multi-pronged, proactive and conscientious approach taken by the government to extinguish these risks and seed long term economic growth drivers. We applaud the prudent fiscal management, higher quality expenditure spending, higher reliance on non-tax revenues in the downturn, steady supply side tax reforms and more transparency in fiscal accounts. On monetary policy, the RBI change of focus toward efficient transmission has started to reflect in the performance of Government securities. Credit spreads, however, remain closer to their widest levels in last ten years reflecting subdued corporate earnings, weak private investments, lacklustre exports growth, and heavy reliance on the government to revive both the investments and consumption cycle. Moreover, the NBFC asset quality crisis which started in September 2018, has continuously created second order liquidity issues among other weaker financials. This environment has now disrupted India’s fifth largest private sector bank, Yes Bank. Intensified concerns on capital adequacy gaps prompted the RBI to overreach and put bank under moratorium and reconstruction scheme proposal on March 6. While this event is long term structural positive, RBI has taken two drastic measures which can have a ripple effect on financials, firstly a withdrawal cap on depositors at INR 50000 during the period of finalization of reconstruction scheme can trigger negative chain reaction for small and mid-sized banks and secondly, the proposal of preserving the common equity capital while writing down a capital security instruments (Additional Tier 1 capital) senior to it, in the capital structure that can further widen credit spreads from current historical elevated levels. We continue to watch these trends closely for impending normalization in credit spreads.