Foreign investors are growingly increasingly bullish on Indian debt due to the yield pick-up over other sovereigns, expectations the central bank will steadily continue to support rates and belief the country will maintain its investment-grade rating.
Positive momentum in Indian sovereign bonds is likely to continue and analysts expect a 60 basis point (bp) drop in both the 10-year and 30-year sovereign yield. The sovereign 10-year bond is currently yielding 7.94%, down from 8% at the end of December and 8.18% the month before that. The 30-year is yielding 8.148% at the time of going to press.
“The yield differential is pretty high between the Indian sovereign and other sovereigns, so the so-called carry is good. There is also an expectation that the central bank might cut interest rates throughout the year so that will entail capital gains for these investments,” said Samiran Chakraborty, head of regional research for South Asia at Standard Chartered.
The RBI delivered on market expectations of a 25bp policy rate cut to 7.75% on January 29 and has indicated that more monetary easing is likely.
“Our bullish view is mainly because we continue to believe the central bank will cut rates and that, combined with the deficit, means the demand for bonds will remain strong,” said Rohit Arora, fixed income strategist at Barclays.
Onshore support for the bonds will also continue to be strong due to two main factors, according to Vivek Rajpal, India-based rates strategist at Nomura.
“Number one is demand from the banking system. It’s a low credit growth environment at the moment in India and so banks have no choice but to assign a significant chunk of their deposits to sovereign bonds. Number two is that the RBI is conducting open-market-operations (OMOs),” he said.
In addition, there is a renewed focus on reforms, which is positive for the Indian currency and is likely to ease the perceived macro risks arising from the country’s high current account and fiscal deficits, according to Arora.
India’s finance minister P. Chidambaram appears to be committed to keeping the fiscal deficit in check, referring to next year’s deficit targets – 5.3% and 4.8% of GDP – as red lines that he will not breach, said Art Woo, sovereign ratings analyst at Fitch.
“In September and October last year, the government adjusted fuel subsidies and outlined a five-year roadmap aimed at reducing the central government fiscal deficit to 3% of GDP by 2016-2017. It also announced that greater foreign investment participation will be allowed in some industries, including power and retail,” said Woo.
Since then, Indian authorities have said they may raise taxes and cut expenditures as well as reducing subsidies.
Investors have long been wary of India’s growing current account deficit, heavy debt burden and turbulent political climate. Rating agencies Fitch and Standard & Poor’s both downgraded their outlooks on the country’s ‘BBB-‘ rating to negative. Moody’s still rates India ‘Baa3 stable.’
“The rating downgrade fears that were there in 2012 are much lower now, given the recent reform measures. Plus the government is streamlining the procedural issues surrounding who can invest [in the sovereign bonds] and what kind of documentation is needed. That was a sticking point, so this will increase demand,” said Chakraborty.
On January 24, the Reserve Bank of India (RBI) increased the FII limit in government-dated securities by US$5 billion, to US$15 billion. Combined with the existing limit for government securities of US$10 billion, the total FII limit now stands at US$25 billion.
According to Rajpal there will be more than enough demand to fill the larger quota. He believes it’s possible that the government could raise the limit further, but not until the recent quota has been filled.
“I wouldn’t be surprised if they open up the FII quota even more, but a lot of foreign investors complain that the registration process is quite complex and the taxes are high for both government and corporate bonds. If they can address that it would help the current account deficit to an extent,” said Arora.
However, there a risk his expectation of a sovereign rally is the possible loosening of fiscal policies in the run-up to the 2014 elections. However, this is unlikely to have a near-term impact in light of the government’s recent reform rhetoric.