Way ahead for Indian’s bond market amid the fiscal woes and RBI’s monetary stance

2019 seems to be a better year for the bond markets

2019 seems to be a better year for the bond markets

The year 2019 is slated to be an exciting year for the Indian Bond markets after a rather tumultuous 2018, which saw the IL&FS saga, unfold in front of our eyes. NBFC’s and HFC’s bore the biggest brunt of the fiasco amidst liquidity squeeze pushing up their cost of funds significantly, year 2018 also saw low corporate bond issuances down by as much as 13% amidst higher cost of borrowing and overall liquidity challenges in the NBFC segment that dominates corporate bond market with a nearly 85% market share.

Positives

2019 seems to be a better year for the bond markets, global headwinds around crude have subsided to an extent with crude trading around levels which are comfortable from an Indian perspective, macro-economic parameters have shown consistent improvement. The Central Bank has lowered its short term and medium term inflation forecast and there has been a shift in the monetary policy stance from calibrated tightening to neutral, we have already seen a 25 bps rate cut and the chances of another rate cut cannot be ruled out.

The biggest positive for the bond markets, however, is the easing of liquidity concerns in the debt markets. January data suggests that corporate bond issuances are up by 30 percent in January indicating that investors have regained confidence in the Indian bond markets. What’s more interesting is the fact that the issuance of new debt by NBFC’s has again reached a healthy 80 percent of the total debt issuance, this number has fallen to low seventies around the timeframe of IL&FS fiasco.

The weighted average cost of borrowing through the Commercial paper has also tapered down by almost 60 basis points as per the recent data from January. Average NBFC commercial paper is yielding 7.76 percent as against the 8.5 percent yields during November last year. Stronger names such as Bajaj Finance, L&T Finance and central PSU such as PFC and NABARD are favorites with the investors.

Concerns

The key concern for the bond markets would be the outcome of general elections, furthermore, the continuation in the positive trend in the credit off take, the overall liquidity situation along with the interest rates trajectory would be the key data points the bond markets would be looking for. The bond markets would also keep a close eye on the fiscal situation post the elections, at present in the interim budget, the fiscal deficit for FY 2019 has been pegged at 3.4% of the GDP and the projected deficit for FY 19-20 is also pegged at 3.4% of GDP although the deficit targets are in breach of the Fiscal Responsibility Act but on a percentage basis it’s not too far off, however on an absolute basis, the bond market is gearing up for a barrage of unrelenting government debt supply. On a gross basis, Government debt to the tune of INR 7.1 trillion will hit the bond markets, which could push yields north.

Though it is widely believed that the Government borrowing from the market next year would be actually higher than expectations, the RBI has been executing Open Market Operations (OMO) purchase of G-Secs, which reduces the effective net supply of fresh bonds to the market thereby keeping yields in check. The bond markets are expecting the RBI to continue with its OMO operations effectively as in the recent past, any disruptions to RBI OMO’s would not be a positive development for the bond markets.

Investment Thesis

In spite of a few concerns, India debt market is poised to do well in 2019. Improving domestic macros, low inflation and a change in the monetary policy stance suggests that the interest rates will continue to remain low in the short term. Global factors such as the US/China tariff war have eased off to an extent, in addition, the softening of the US Fed’s stance on interest rate hikes amidst global recession chatter further suggests that yields are not going to rise substantially at-least in the short term, all these are positive developments for bond investors. It is advisable to invest in shorter maturity products, such as short duration funds, liquid funds etc. to have relatively lower volatility and interest rate risk in your portfolio. Current allocations to fixed income can be possibly overweight into short term/credit accrual funds. Some exposure to actively managed gilt/bond funds could also be considered for diversification purposes and for scenarios where yields pick up from their current lows.

Finally, after a rather tumultuous 2018, bond investors are expected to have some respite in 2019, there are few uncertainties around the election results and some nervousness due to the recent developments at the border. Bond investors can be cautiously optimistic about their investments prospects and are advised to stay on the short end of the yield curve to minimize volatility and interest rate risks in the short term and near term.


-This article has been contributed by Rahul Agarwal, Director, Wealth Discovery/ EZ Wealth

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