The year 2018 has been a yoyo year in debt markets. From a clamour for rate hikes to a whisper of rate cuts, the markets have seen a large move in both directions over the course of the year. The year was also an eventful one for debt market participants. From the flip flop on policy action to the spat between the Reserve Bank of India (RBI) and the government to the IL&FS default (pegged as India’s so-called Lehman moment) and the risk of contagion in the NBFC (non-banking financial company) space, the year has been an eventful one. Despite 2018 being a year of negatives, the bond market outperformed equity markets for the year. The year 2019 is likely to be a year of reversals, furthering the investment case for debt markets.
The year gone by
Debt investors in the short to medium term space have been rewarded as they rode the see-saw moves in the debt markets. The year has ended with debt returns outperforming equity markets in many debt mutual fund categories. Credit risk was brought to the forefront once again, highlighting that debt funds are not risk-free investments and investors should heed caution while investing in relatively high-risk, high-reward debt products. The higher credit risk scenario has since diminished as reflected in normalised prices across the yield curve
Crude has been an impediment to the India story over the past few quarters. From a low in 2016 of approximately $30 per barrel, crude prices jumped to $82 per barrel in mid-September 2018 raising concerns on inflation and a possible breach of the fiscal deficit targets. A sharp reversal over the past few months has raised optimism levels given India is a large crude importer. This has also reflected positively across rates and the currency. We anticipate crude to remain fairly volatile over the next year given heightened geopolitical tensions and the demand-supply mismatch.
India remained a relative favourite with foreign investors looking at emerging markets despite the overall global shift away from emerging markets. This is due to the bright spots of opportunity India continues to offer. It also retained its tag as the fastest growing nation by GDP growth rate as growth waned across most of the developing world amid a sagging global economic environment. Currently, India continues to offer high real rates and a stable currency and hence remains a strong contender for foreign debt capital.
GDP numbers should be seen in context of a normalising base post GST implementation. While the full impact of GST on the GDP base has not been captured, we anticipate the high crude oil prices during the quarter may have exasperated the downtick. This is likely to get balanced out in the coming quarters. The long-term story continues to remain intact given the strong high frequency numbers and strong corporate earnings.
Concerns over Liquidity
The IL&FS default sent shock waves across the NBFC space in early August 2018 as concerns over asset liability mismatches and poor risk management protocols in the quest for a growth blitzkrieg were brought to the fore. Timely action by RBI and confidence building measures by the government alleviated much of the contagion risk. An already dislocated bond market favouring short-tenor debt instruments saw some degree of aggravation as market participants took a back seat and were in a wait-and-watch mode as news flow drove debt market valuations. This was a short-term market liquidity crunch and re-emphasised the need for continuous credit evaluation and responsible investing. Fund houses with prudent lending philosophies and strong credit appraisal processes came out as big winners setting an example for the rest of the industry. The market is now slowly finding its way back to normalcy as rates have returned to pre-crises levels.
Outlook for the new year
We do not believe that there is material risk of financial instability and hence RBI is likely to continue to focus on inflation trajectory. With the current inflation trajectory and RBI’s inflation projection for the year at 4%, we don’t see significant moves on the repo rate front for the rest of the financial year. As the shadow of the IL&FS saga and the NBFC liquidity crunch recede, 2019 is likely to be a better year for debt against the backdrop of lower crude and stable macros. However, the fiscal position is likely to remain an overhang given that current GST collections are far lower than budgeted expectations and non-tax revenue growth continues to remain tepid.
Currently, the curve offers significant opportunities from the investment perspective as markets are pricing in more than one hike till March 2019. Corporate bonds in the 1-3-year space currently trade at a premium of 200 basis points over the operative rate which we believe offers material opportunities and hence prefer this space.
R. Sivakumar is head, fixed income, Axis Mutual Fund