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Where are Indian bond markets headed? - Outside View by PersonalFN
Where are Indian bond markets headed?

In his budgetary speech, the finance minister had highlighted the importance of having efficient and well-developed debt market in India. India needs to invest massively in infrastructure in order to grow faster. It is said that, debt markets may play a crucial role in mobilising funds from investors to corporate.

Recently, Indian Railway Finance Corporation (IRFC) was forced to cancel bidding on bond issue. It was aiming to raise Rs 3,000 crore through issuance of bonds with tenure of 2 years. It is believed that, investors were demanding a coupon rate of 8.38% to 8.50% while IRFC was willing to offer only 8.27%. Foreign Institutional Investors (FIIs) couldn't participate in the bidding as the tenure of the bond was less than 3 years. The RBI restricts inflow of foreign capital in bonds with less than 3 years' of residual maturity. This incident brings forth a few facts;

  • Domestic investors are willing to put money in bonds only at higher coupons

  • Only foreign investors are willing to accept bonds at lower yields
Going by the latest available figures, Foreign Institutional Investors (FIIs) have already exhausted 99.5% of the limit applicable on their investments in sovereign debt. FIIs are allowed to invest USD 30 billion in G-secs. However, the limit for investing in corporate bonds remains noticeably unutilised (around 30% is unutilised). This also suggests that, FIIs are willing to accept lower coupons only for papers with high credit quality. On this backdrop it remains crucial to see where Indian debt markets are headed here onwards especially considering that RBI has already reduced policy rates twice in last 3 months.

Factors to watch out for...
  • Trends in retail inflation

  • Monetary policy stance of RBI

  • Action of Federal Reserve (Fed) pertaining to interest rates in the U.S.

  • Performance of the Government on the fiscal front

  • Progress of the Government on implementing the reform agenda
Retail inflation as measured by the movement of Consumer Price Inflation (CPI) has come in at 5.37% in February. At 6.76% food inflation appears moderate too. However, the moderation in inflation was in line with expectations of RBI. The central bank expects inflation to stay lower in the first half of 2015-16 before firming up in the second half. Moreover, RBI aims to maintain inflation at 4% (with a variation of + /- 2%) by the end of a two year period starting fiscal year 2016-17. Apart from having lowered policy rates in January 2015, RBI lowered rates once again on March 04, 2015. This was in repose to initiatives taken by the Government to improve supply side constraints and disciplined approach adopted in fiscal management.

While most of these positives are already factored in the bond prices; now it remains to be seen how bond markets react in case Federal Reserve goes ahead and hikes interest rates in the U.S. It is anticipated that, strong job market data in the U.S. may get Fed thinking about hiking interest rates sooner or later. It is unlikely that the impact of such a move has been taken into account by the Indian bond markets. Therefore, if foreign capital moves out of India, yields might go up thus pushing bond prices down.

Considering the bad state of public sector banks, it remains to be seen how corporates draw up their fund raising plans. The demand might come only at higher coupons and in such a case there might be a pressure on banking channels. Short term rates are likely to remain stable, except for some spike up on account of liquidity pressure that might arise in wake of advance tax payments and demand for funds by telecom companies on account of spectrum auction 2015. Otherwise, liquidity may stay comfortable.

What investors should do?

PersonalFN is of the view that, softening of yields and unidirectional rallies in bonds might be over for now. Going forward, bonds including G-secs are likely to show a range-bound movement. Under such circumstances, it is advisable that one shouldn't speculate on aggressive rate cuts by RBI and refrain from betting aggressively on long term debt funds. Unless you have a time horizon of more than 3 years, you should avoid investing in long term debt funds. Those who have a time horizon of over 3 years may also restrict their investments upto 20% of their debt portfolio. As of now, yields on 3-month CDs and even on 1-Year CDs appear higher than that of 10-Year G-sec benchmark bond. It is expected that, the yield curve, which is slightly inverted now, may normalise a bit, going forward. Don't be surprised if short term debt funds outperform long term income funds, over next 12-15 months.

This article has been authored by PersonalFN, a Mumbai based Financial Planning and Mutual Fund Research Firm known for offering unbiased and honest opinion on investing.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.


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