BackIDFC MF lays down roadmap for living through financial repression
Indian savers should accept the reality of low yields for relatively safe paper. For instance, this could be very short-dated government securities, which minimize both duration and credit risk.
PremiumIDFC Asset Management Company has warned investors that financial repression may actually get worse in the post-covid-19 world. Financial repression is the policy driven by suppression of real interest rates in order to benefit borrowers and stimulate the economy.
In a letter to investors, the AMC’s head of fixed Income, Suyash Choudhary, said that this phenomenon is happening across the world, including the US. “The Federal Reserve is actively endorsing an ever increasing fiscal package thereby effectively underwriting the large swathes of new public debt that are thereby getting created. This is a break from most instances in the past where central banks have normally pushed against excess fiscal expansions," he wrote.
For India, Choudhary feels that the repression can only last for the short term. This is because India does not print the world’s reserve currency (US dollar) and because India’s current account deficit (CAD), which is cyclically depressed, will come back when growth starts to revive.
However, the Indian debt market has steep yield curves and higher credit spreads. A steep yield curve means that effectively higher interest rates are offered for longer-dated debt. This is to compensate savers for the uncertainty of government financing longer-dated paper.
A credit spread means that debt paper from lower credit quality borrowers pays higher yields than paper from higher credit quality borrowers. These spreads compensate savers for the higher risk they take on, when they put money in riskier paper.
Choudhary cautioned investors from trying to take advantage of these two higher return options.
According to him, Indian savers should accept the reality of low yields for relatively safe paper. For instance, this could be very short-dated government securities, which minimize both duration and credit risk. They can tactically allocate to higher duration debt to some extent or place a small part of their portfolio in longer-dated debt. However, he warned strongly against moving into lower-credit paper. “Such positions are prone to sudden illiquidity and hence may end up trapping investors," he added.
Amol Joshi, founder, Plan Rupee Investment Services, concurred. "With an environment of uncertainty related to covid-19 continuing, investors would do well to stick to highest credit quality segment. Investors with a view that rates will go lower may add duration to part of their portfolio in anticipation of higher returns via capital gains," he added.
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