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Would Iraq crisis play a spoilsport for Indian debt markets? - Outside View by PersonalFN

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Would Iraq crisis play a spoilsport for Indian debt markets?
Jun 21, 2014

Oil is on the boil these days. There is a fear that, civil war-like conditions in Iraq may disrupt the oil supply across the globe. Iraq stands fifth on the list of countries having the highest proven oil reserves. It is the second largest oil exporting nation amongst Organization of Petroleum Exporting Countries (OPEC) and India's second largest oil supplier. And India being an Oil deficient country, the crisis in Iraq may be a threat to India. You can see the impact already. Rupee has started declining against dollar. There is some amount of discomfort among investors, although, market reaction remains neutral for now. PersonalFN tells you how Indian Rupee and the Indian bond market may be affected, going forward.

Impact of Iraq Crisis on Indian bonds...

As the news of eruption in Iraq came forth, yield on India's 10-Year G-sec benchmark bond rose. But thereafter, bond yields declined mildly. This suggests that, Indian debt markets so far have not impacted much by the Iraq crisis. Indian rupee is down about 2% from the beginning of June, which is a concern.

Movement of Yield on 10-year G-sec benchmark bond
(Source: Economic Times, PersonalFN research)

Foreign institutional investors (FIIs) have invested close to Rs 16,950 crore in Indian debt since the beginning of this month. It is noteworthy that the net daily inflows were positive even after the news of Iraq crisis broke although thereafter they have slipped mildly in negative.

Is impact on India very limited?

Oil from Iraq meets more than 13% of India's daily import needs. However, 3/4rd of the oil production of Iraq comes from its south region. The southern region is less affected by violence and oil production in the southern parts has not yet taken any major hit. Most of oil wells are located in Kurdish and Shia regions. Iraq being Shia dominated country, people of these regions are supporting the Government to fight against Sunni rebels. Oil prices may not be affected much, until southern region remains protected from this crisis. This is already evident. As a spontaneous reaction Brent crude oil Prices had almost surpassed $115 dollars per barrel last week but prices settled a bit lower later. The key is not letting violence spread in the southern region. So far, Iraqi government has managed to protect south regions and its oil resources. It is also seeking help from US to come to its rescue against Sunni rebels.

What if crude oil prices rise further?

As reported by Reuters, based on inputs from two government officials, for rise of every dollar in crude oil prices, government incurs an additional cost of Rs 7,000 to Rs 7,500 crore on giving oil subsidies to refiners. Moreover, current account position of the country may weaken due to higher import bill of crude oil. The cascading effect could be price hikes for consumers. A rise of Re 1 per liter on diesel may trigger inflation by about 0.8% to 1.0%. Higher inflation and higher fiscal deficit would be a double blow for Indian debt markets. Moreover, RBI may have little scope for cutting policy rates. If interest rates stay high, the Indian bonds may continue to remain under pressure.

Markets have experienced a fall of around 0.4% in yield on 10-Year G-sec benchmark bond since April 2014. This had changed investor sentiments. Investors were hopeful of some rally in long term securities. But it could not last long. Going by current developments, PersonalFN believes, investors should refrain from speculating on direction of interest rates. Unless oil prices go down, containing inflation and fiscal deficit would be difficult for the government. PersonalFN believes that the risk in long term income funds is high even today.

This is precisely why PersonalFN always recommends its investors to invest not more than 20% of their debt portfolio in long term income funds. Debt can be as volatile as equity. So do not treat debt instruments and debt funds as a safe investment.

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


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