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India fixed income strategy: Standing tall in a low yield world

Gordon Rodrigues, Head of Asian Rates & FX discusses the key opportunities in the India fixed income market given the latest policy moves.
26 August 2019
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    Key takeaways:

    • The Reserve Bank of India (RBI) has shifted its monetary policy stance twice and cut the key policy rate at each of the four MPC meetings year-to-date, arriving at the current “accommodative” policy stance and a repo rate of 5.40 per cent
    • An accommodative policy stance and open minded approach towards ensuring adequate liquidity are constructive for rates
    • With global growth slowing down and central banks in rate cutting mode, investors will need to look at places like India in order to generate a reasonable carry within an environment that delivers political stability and an economic reform agenda
    • As Indian bonds offer a premium to other developed as well as emerging markets, with an attractive 6.6 per cent yield on its 10-year government bonds, exposure to India can potentially improve the yield of a global portfolio
    • HSBC Global Asset Management has a strong presence in India fixed income investment, managing USD 25 billion in domestic and offshore Indian bonds. We provide global investors the opportunity to access higher yields in a relatively uncorrelated market

    The information contained in this publication is not intended as investment advice or recommendation. Non contractual document. This commentary provides a high level overview of the recent economic environment, and is for information purposes only. It is a marketing communication and does not constitute investment advice or a recommendation to any reader of this content to buy or sell investments nor should it be regarded as investment research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of its dissemination. The performance figures displayed in the document relate to the past and past performance should not be seen as an indication of future returns. Any forecast, projection or target where provided is indicative only and is not guaranteed in any way. HSBC Global Asset Management accepts no liability for any failure to meet such forecast, projection or target.

    What are the implications of the RBI’s dovish monetary policy on the Indian fixed income market?

    India’s interest rate outlook has changed considerably since the beginning of the year. The Reserve Bank of India (RBI) has shifted its monetary policy stance twice and cut the key policy rate at each of the four MPC meetings year-to-date, arriving at the current “accommodative” policy stance and a repo rate of 5.40 per cent – which is a result of a total rate reduction of 110bp so far this year. Overall, the RBI’s easing actions come on the back of a slowdown in domestic economic growth, subdued inflation numbers, and headwinds from the global front.

    At its most recent MPC meeting on 7 August, the RBI reduced the policy rate by 35bp, which was higher than expected and a departure from the norm of the 25bp multiple. At this meeting, the RBI projected that inflation will stay within the target over the next 12 months and also emphasised that it is prioritising boosting aggregate demand, especially private investment. As inflation is within target and with sufficient liquidity in the system, a preemptive rate cut such as this provides the necessary monetary ammunition for growth.

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    10-year yields versus policy rate

    (%)

    10-year yields versus policy rate

    Source: RBI, Bloomberg, as of 20 August 2019.

    With the RBI retaining an accommodative monetary stance at the last meeting and indicating that it will be data dependent, we believe that further rate cuts remain on the table. Given the unconventional rate cut of 35bp, going forward, cuts of less, or greater, than multiples of 25bp cannot be ruled out. The key criteria underlying future rate decisions, we believe, is growth. As the RBI’s 2HFY20 GDP growth estimates seem optimistic, slower than expected growth could prompt the RBI to initiate further rate cuts.

    System liquidity has been in large surplus in June-July 2019 due to the RBI’s open market operations (OMO), FX operations and government spending. The RBI has stated that it will ensure there is sufficient liquidity in the system for all productive needs and for adequate transmission by banks in a rate cut cycle. Going forward, the RBI may continue to use a combination of tools to support liquidity and we expect liquidity to remain in the neutral to surplus territory.

    Overall, an accommodative policy stance and open minded approach towards ensuring adequate liquidity are constructive for rates. The substantial amount of easing in both rates and liquidity, amongst other factors, has helped tighten 10-year government yields by 75bp year-to-date and bring yields to a 2-year low, currently standing at 6.62 per cent (as of 20 August).

    Overall inflation well within RBI’s range

    Year-on-year increase (%)

    Overall inflation well within RBI’s range

    Source: RBI, Bloomberg, as of 31 July 2019.

    How are you positioning your India fixed income strategy given the policy moves?

    While being marginally underweight duration, we are overweight INR government bonds, with a predominant positioning in the 5-10 year part of the curve. We see this part of the curve benefitting from the RBI’s openness to cut rates and maintain adequate system liquidity.

    Given the persistence of the rate cycle and lower oil prices, our recent additions in the 10-14 year segment based on curve steepening should benefit from the shift lower in the yield curve.

    We are also overweight INR corporate bonds with a focus on the 3-5 year part of the curve which should benefit from four consecutive rate cuts in the last eight months, and as lending rate cut transmission improves. The carry in these segments is still attractive at current levels. We also have exposure to some liquid 10-year corporate bonds given attractive spread valuations.

    We continue to be underweight USD Indian credits on a relative basis to onshore bonds with US Treasuries moving lower and relatively tight credit spreads.

    What are some of the key opportunities and risks investors should be aware of for the rest of 2019 and 2020?

    With global growth slowing down amid trade tensions and with central banks in emerging and developed economies in rate cutting mode, investors will need to look at places like India in order to generate a reasonable carry within an environment that delivers political stability and an economic reform agenda. Foreign investors will also be looking at the possible issuance of a foreign currency bond by the Indian government as a way to gain exposure to the country. Further, structural shifts including lower interest rates and inflation, reduced fiscal deficit, infrastructure upgrades and inclusive developmental efforts remain medium term opportunities investors would want to take advantage of.

    From a risk standpoint, a large move up in crude oil would be disruptive to India’s current account deficit and currency with less implications for inflation. However, oil prices have been relatively benign and in a range due to the slowing global growth scenario and oil supply/demand situation, which should continue in the near future. Food inflation, meanwhile, is increasingly being less impacted by seasonal/monsoon factors given the improved dynamics of food management by way of supply side intervention, building buffer stocks, market intervention and using minimum support prices (MSP) to influence cropping behaviour.

    Fiscal prudence has been at work over the years with the fiscal deficit as a percentage of GDP falling from the 5-6 per cent range to 3.3 per cent in the revised budget. However, given the economic slowdown globally, and reduced growth rates locally, there is pressure on the government to expand the fiscal deficit to kick start the economy. Although we are of the opinion that fiscal prudence will dominate given the track record of the current government, further tightening may need to be stretched out.

    From a credit risk standpoint, banking/non-banking finance sector reform is critical and hence, in our India fixed income strategy, we continue to have exposure to the top end of the credit risk spectrum at this point.

    Central government fiscal deficit

    per cent of GDP

    Central government fiscal deficit

    RE – Revised Estimates; BE = Budget Estimates
    Source: Budget documents, HSBC Global Asset Management, as of July 2019

    Are you concerned about India’s slowing growth?

    While slowing growth is normally a positive for bond markets, the impact of slowing growth on the corporate sector can be negative from an equity standpoint. With the current account deficit expected to range around 2.0-2.2 per cent of GDP, foreign portfolio investment (FPI) flows are going to be critical to achieving a positive balance of payments. The government needs to make sure its various reforms kick in to improve both the demand side as well as the growth of credit to ensure that FPI flows stay positive, particularly as the currency rate is influenced by equity flows in the short term.

    What is the case for investing in Indian bonds and how is your strategy different from the market?

    India is a fast growing major economy, with a substantial focus on structural economic reforms. The Indian domestic bond market is also large and liquid, having grown rapidly to USD 1.7 trillion in size. While about two-thirds of the market is made up of government bonds, the corporate market is likely to grow strongly in the coming years

    Domestic bonds outstanding

    INR bn

    Domestic bonds outstanding

    Source: RBI, SEBI, as of March 2019

    As Indian bonds offer a premium to other developed as well as emerging markets, with an attractive 6.6 per cent yield on its 10-year government bonds, exposure to India can improve the yield of a global portfolio. Importantly, India has a low correlation with other bond markets; this could be because the market still has restrictions on foreign investors – who are allowed to own a maximum of just 6 per cent of outstanding government bonds – and is still largely influenced by local factors in terms of its monetary cycle. However, recent reforms have facilitated greater market access for foreign investors and have helped widen the investor base and increase inflows from overseas investors. Investment in an Indian fixed income mutual fund product is one of the ways to access the domestic bond market.

    HSBC Global Asset Management has a strong presence in India fixed income investment, managing USD 25 billion in domestic and offshore Indian bonds. We were one of the first global managers to launch a UCITS product in India fixed income in 2012; the size of this product has grown and surpassed USD 1.1 billion in size. Our strategy is managed by an award winning team, based in Hong Kong, and supported by an on-the-ground investment team in India. With an integrated approach towards fundamental research and local insight and a robust rate process, we provide global investors the opportunity to access high yields in a relatively uncorrelated and largely domestically owned emerging market.

    India 10-year bond yield attractive relative to peers

    Yield (%)

    India 10-year bond yield attractive relative to peers

    Source: Bloomberg, data as of 20 August 2019

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