By Sanjay Sachdev
The government securities (G-sec) markets comprise central government and state government issuances while the corporate bond market consists of a) public state undertakings bonds (PSU) where central government has a stake of 51% or more in the company; and b) corporate bonds issued by privately owned entities. Indian fixed income markets operate in a number of different instruments ranging from short-term instruments to longer-term bonds (maximum 40 years in G-sec).
Since 2005, the corporate bond market in most developing countries (including both domestic and international issuances) have grown faster than their overall economies. Notably, Brazil, Russia, India, China and Turkey have all seen their corporate bond markets grow at over a 20% compound annual growth rate between 2005 and 2014. As emerging corporate bond market values have grown, an increasing proportion of the issuances have been on domestic markets and in local currency. The value of domestic corporate bond markets grew from 18% of emerging countries’ GDP in 2005 to 23% in 2014, while internationally issued emerging corporate bond values grew from 4% to 6%, respectively.
In India, the risk of investing in below AAA rated corporate bonds continues to remain high. A possible global slowdown would put pressure on domestic growth impacting highly leveraged companies which would face greater stress on their balance sheets and potentially lead to pressure on cash flows. We feel the risk reward of exposure to sub-AAA rated securities to boost portfolio yields is not adequate given weakness in the current credit environment remains.
India is the third largest economy globally based on a purchasing power parity (PPP) GDP of USD 7.39trn as of 2014. Its nominal GDP was USD 202.86bn in 1982 and has since grown to USD 1.99trn, a nine-fold increase according the IMF. India’s real GDP growth year-on-year has grown at a sustained level at an average of 6.2% for last 33 years with no negative annual year-on-year growth rate. The average GDP growth forecasted is 7-7.5%, the highest among the larger EM economies.
Unlike other emerging countries, such as China, India has solid aggregate demand and a consumer-driven economy. At the international level, India enjoys diversified exports including software, iron ore and non-commodities merchandise like machinery and chemicals. But it is the prevalence of a consumer-based economy that gives the country a big advantage over many other emerging markets that are overly reliant on commodity exports.
India currently benefits from lower import costs on commodities such as crude oil resulting in a lower current account deficit and fiscal deficits as well as lower fuel inflation. RBI has set the retail inflation target at 5% by 2017. Even though the Consumer Price Index rose to 5.8% during May’16, going forward the inflationary pressures are likely to be abated by bountiful farm output backed by above normal monsoons. India’s external vulnerability has also reduced considerably in the last few years. The foreign exchange reserves of around USD352bn will provide a solid defence during global instability while the Indian Rupee has been stable in the recent EM currency turmoil.
Investors are optimistic on India and sentiment is favourable following the government’s announcement of a series of reform measures in recent months. Economic growth prospects are well documented and buoyed by strong support from the government, interest from Foreign Institutional Investors (FII) has been strong and is expected to continue to improve going forward. FII’s are particularly attracted to Indian bonds with the strong support for the Reserve Bank of India and the government combined with benign commodity prices to further add confidence. Indeed, Sovereign Wealth Funds’ holdings in Indian debt has reached an all-time high of INR 330.16bn (as at 12 July). The spread of 10-year yields on US Treasuries over Indian Sovereign Bonds is at 582 bps (long term average is 436 bps), which is very attractive given India’s stable macro position, higher growth prospects and investment grade ratings. India is rated BBB- (Stable) by S&P and Baa3 (Positive) by Moody’s and has consistently been rated as investment grade status by all major rating agencies for the last 14 years. Going forward India’s sovereign rating may warrant a ratings upgrade backed by GDP growth of 7.9% during Q4 FY16 and a pickup in consumption demand along with commitment to meet fiscal deficit target of 3.5% of GDP.
Sanjay Sachdev is executive chairman at ZyFin
