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Below is the Views Debt by Pankaj Pathak, Fund Manager-Fixed Income - Quantum Mutual fund
Bond markets had a strong run in the recent months. Supportive macro conditions both in the domestic and global markets drove the bond yields significantly lower across the maturity curve.
The 10 year government bond yield which was quoting around 7.4% in April fell to 6.9% by the June end. It declined further to 6.7% post the Union Budget announcement in which the Government kept its fiscal deficit target at 3.3% of GDP and proposed to tap the global markets through Dollar denominated bonds.
The government’s fiscal commitment has come as a relief to the bond market which was anticipating an increase in fiscal deficit to stimulate the sluggish economic growth. However in order to meet the 3.3% Fiscal Deficit Target the Government has projected over 18% growth in the tax revenue which looks optimistic even after adjusting for the increased excise and custom duties.
Another positive announcement from the bond markets prospective was the proposed issuance of the Indian government bonds in the offshore market. This move will surely broaden the investors’ base for the government’s borrowing program and might also lower the cost marginally if value of INR remains stable. But we need to understand that foreign debt is a double edged sword and it can compound the economic problems in bad times.
Indian government and the RBI have thus far, very rightly so, resisted this temptation of raising money overseas and subjecting itself to the whims and fancies of the global banking system. We hope the government will keep a tight cap on its external debt.
This government has been exemplary in the last 5 years in improving the overall macro situation by controlling inflation, keeping fiscal deficit under check and ensuring that Real Interest Rates remain positive. These are three main things desired by global investors while investing into Indian rupee denominated government bond. Thus, instead of raising money overseas, the government should have displayed more confidence by increasing the limits for foreign investors under the FPI route into the Indian Government Bond market and encourage global investors to invest in India and help develop the local bond market.
Another crucial aspect of this budget was a liquidity boost for non-bank finance companies which had been under stress for last three quarters. The government has extended a guarantee to PSU banks to absorb upto 10% of loss from the pooled assets of upto INR 1 trillion purchased from ‘healthy NBFCs’.
This seems like a good step to bridge the trust deficit and it may revive the credit markets somewhat. But the amount is small in context to the size of some of the troubled NBFCs and we have to wait to see its actual impact on the bond markets. At this point investors should remain cautious about credit risk in their debt exposure.
Overall macro backdrop remains supportive for the long duration bonds. The CPI inflation, despite a near term raise, will remain well within the RBI’s threshold of 4%. The RBI is likely to reduce the policy Repo rates by at least 50bps in rest of 2019.
The bond market has rallied a lot in the last two months. However, there is still some scope for further decline in bond yields (rise in prices) given the possibility of rate cuts and the prospect of an overseas dollar bond issue.
Bond funds with longer maturity profile may benefit from the rate cuts though liquid fund returns will likely to fall with the cut in Repo Rates and the desire to keep surplus liquidity. Dynamic Bond Funds, which allow the fund manager flexibility to change the portfolio positioning depending on the emerging situation is a better alternative for the investors who wish to allocate to bond funds and can have a holding period of 2-3 years.
Investors with low risk appetite should stick to Liquid Funds to avoid any sharp volatility in their portfolio value. However, while choosing such funds also one should be aware of the credit risk and prefer funds which take low credit and liquidity risks.
Investors should also note that the credit crisis which began in the bond markets in September 2018 is not over yet and investors should remain cautious and should always choose debt and liquid funds which priorities safety and liquidity over returns in the current times.
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