Bond yields have moved up, in tandem with global bond market nervousness. HDFC MF's fixed income team takes a quick look at what's changed on the ground domestically, and finds that none of the interest rate drivers have deteriorated - in fact all the key numbers - inflation, inflation drivers, CAD, fiscal deficit and economic activity - are all pointing towards lower interest rates. If fundamentals are looking good and sentiment has resulted in yields hardening instead of softening, wouldn't you agree with Prashant's team that opportunity is indeed knocking again? Take a look at the note that HDFC Fixed Income team has put together some points on whether one should add duration into portfolios now.
A summary of the recent changes in key economic parameters is given below:
These issues are discussed in greater detail below:
Trade deficit, CAD and INR
As can be seen from the table, CAD for 4QFY15 is likely to be in surplus due to lower crude prices. The recent jump in oil prices has to be seen in light of the fall from $110 to $45 and now bounce back to around $65. Even assuming an average crude price of $70 for FY 16, India would save nearly $20 bn and CAD should still be well below 1% in FY16.
In summary, CAD is in very good shape and is close to the best that India has experienced in a long time. Interestingly, FX reserves have increased by ~$24 bn in the last 3 months. The import cover has thus improved from below 7 months in Sep 2013 to nearly 9 months now.
Inflation
From the above table it is evident that WPI has fallen more compared to CPI and the gap between CPI and WPI is at record levels. Also, since WPI is focussed on B2B prices and CPI on B2C prices, it is logical to expect CPI to fall with a lag. This gap between CPI and WPI makes us optimistic about lower CPI going forward.
Also, generally speaking, the key drivers of inflation in the last few years - rising global commodity prices, depreciating INR, high rural wages growth, large increases in MSP’s, robust demand and weak supply have all reversed and this reversal is supportive of lower inflation on a sustained basis in our opinion.
Weak credit growth
Bank credit growth has been sluggish and is at record low levels. This clearly shows weak demand conditions generally and weak capex cycle specifically.
US yields rise
The US 10 yr Gsec yields have risen from 1.65% to 2.15%. There is still no consensus about the outlook for US rates. In our opinion, US yields will eventually rise, though the extent and timing is uncertain. What is interesting is the near record gap between Indian and US yields, which provides enough room for Indian yields to head lower even if US yields were to rise.
Conclusion and Outlook
All the key determinants of interest rates in India viz inflation and inflation drivers, fiscal deficit, CAD, economic activity point towards lower rates.
The recent strengthening of 10 yr G-sec yields from 7.65% to ~8% is mainly driven by sentiment (global sell off in bonds and bounce back in oil prices after a steep fall) in our opinion and does not change our view of lower rates in 2015 and 2016.
With this 30-35bps rise in yields, the risk reward has turned decisively favourable and we would urge investors to add duration through the following funds^:
We had long told our patrons to invest in Long term Debt funds due to the above factors and have given in writings and papers about the same:
Make sure to invest in Long Term and Fixed Income plans to get benefits of the current economic conditions in the true sense. Only By criticizing the government, you can never achieve anything much, but if you learn to get the benefits of improving fundamentals, you would surely achieve great returns in the coming time.
-With Inputs from Wealth Forum
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