FIIs will keep betting on decent returns from India's debt market
facebooktwitter

2016 Debt Market Outlook

"2016 is going to be another year of strong FII inflows. This belief stems from the fact that Indian macroeconomic situation is expected  to be strong" 

 Jinsy Mathew   

The highlight of the Indian debt market was the increase in foreign institutional investor limit for government securities, which made way for an additional inflow of  Rs1.2 lakh crore FIIs will keep betting on decent returns from India's debt market.

The debt market had an action-packed 2015. For the second straight year, the foreign institutional investor (FII) investment in debt was more than the inflows into equities, on expectations of more rate cuts by the Reserve Bank of India or RBI. This is because at 7 per cent-plus, Indian bond yields were much more attractive than the options in other emerging markets.

"India has one of the highest nominal yields among major markets. The rupee, too, has remained largely stable even as other emerging market currencies depreciated sharply over the past two years. Therefore, foreign investors in Indian bonds have earned fairly high yields with a stable currency. These were among the best returns in the world," says R. Sivakumar, Head, Fixed Income, Axis Mutual Fund.

During the year, the Reserve Bank of India cut the repo rate by 125 basis points (bps), thanks to the moderation in consumer price index (CPI) inflation and the fall in global commodity prices, especially of crude oil.

The price of Brent crude, which hovered around $56 a barrel at the start of 2015, cooled to $42 a barrel. Prices of other commodities such as copper, zinc, aluminum and lead also melted by 15-20 per cent during the year.

Agri commodities also faced the heat due to weak demand. As a result of cheaper imports, India's current account deficit fell sharply, helping the rupee rise against all major currencies, barring the dollar, against which it fell 7.5 per cent.

Other than this, the highlight of the debt market was the increase in FII limits for government securities, which made way for an additional inflow of  Rs1.2 lakh crore.Given the fall in interest rates, debt mutual funds performed well, giving average returns of 8 per cent.

Murthy Nagarajan, Head, Fixed Income, Quantum AMC, says it's time for debt market investors to moderate their expectations for next year. He expects that most returns will come from accrual (coupon payments) and not capital gains.

"The RBI is targeting CPI inflation of 5 per cent by January 2016, but there are several headwinds for achieving this target. We require commodity prices to remain soft and no significant increase in MSP (minimum support prices) for crops next year. Even assuming that disinflationary pressures continue in the current financial year, there will be scope for only one more rate cut," he says. Harihar Krishnamoorthy, Treasurer, FirstRand Bank, says interest rates are at an interesting point.

After dipping to less than 4 per cent, inflation has reversed trend and is around 5 per cent due to base effect and spike in prices of food & pulses. "There are indications that the first quarter of 2016 could see inflation at 5.6-5.8 per cent.

A reduced monsoon, pick-up in food prices, and increased possibility of the Federal Reserve increasing interest rates in its December meeting have taken interest rates higher," he says. As a result, benchmark ten-year government yields have edged up from 7.52 per cent to 7.69 per cent.

Krishnamoorthy says the Fed move is a critical event to watch out for. "Any sharp hike in their rates would put emerging market yields under upward pressure. Inflation also could edge up marginally but soft international commodity prices are expected to provide a strong support to our inflation control objectives, besides help in maintaining fiscal health. Thus, we could see inflation and interest rates stabilising at higher levels."Lakshmi Iyer, CIO (Debt) and Head of Products, Kotak Mutual Fund, says if the Fed rate hike is marginal, it may not have a material impact on market fundamentals.

In fact, the resulting volatility may provide buying opportunities. Her advice to duration investors is to remain invested with a one-three year horizon and increase allocation during moments of opportunity.Will FIIs continue courting Indian debt in 2016 too? Yes, says Nagarajan.

According to him, 2016 is going to be another year of strong FII inflows. This belief stems from the fact that Indian macroeconomic situation is expected  to be strong due to lower commodity prices and lower fiscal deficit in the next financial year.

"The rupee, too, is expected to remain strong against major currencies due to factors like higher GDP growth and lower current account deficit. This should keep FII debt inflows strong," he says.