India is turning out to be a hotspot destination for foreign investors. While equity markets have been buzzing almost for a year now, debt markets have also started catching up lately. For a variety of reasons, the Indian debt was unattractive for investors. Inflation, fiscal deficit and stunted economic growth were some major hurdles. So as an inverse relation, bond prices were under pressure and yields were hardening.

However, there has been some improvement in the market sentiment after the Modi-led-NDA Government was elected to power with a decisive mandate. You see, the benchmark 10-year G-sec yielding after having mounted in April this year, has been on a steady decline, albeit Mid-June, when some pressure did build up again as sectarian tensions in Iraq erupted.

Thus, it seems the tide is turning now, and turning for good. The interest of foreign investors has got rekindled. Franklin Templeton Mutual Fund bought Indian debt worth Rs 16,000 crore in a single day recently under its foreign funds. And eventually in the last week of July 2014, the benchmark 10-Year G-sec yield dropped below 8.5% and there has been steady and range bound thereafter.
 

FII buying...

Data as on August 28, 2014
(Source: ACE MF, PersonalFN.com)  

Dropping yields and highest ever single-day purchase of India’s sovereign debt by a foreign fund indicate that the fundamentals may have turned around.

And indeed the following factors that have turned conducive for the Indian debt market:
 

• Expectation of lesser Government borrowing;
   
• Falling crude oil prices;
   
• Mellowed down inflation;
   
• Steady rupee; and
   
• Expectations of growth revival
   

Moreover, the Reserve Bank of India (RBI) recently decided to transfer the surplus of nearly Rs 53,000 crore to the Government. This would help the Government shore up its finances. As a result the Government is expected to lower the borrowing target for the current fiscal.

Another factor that is playing out positively for Indian bonds has been the falling crude oil prices. You see, despite of crisis in the Middle East region supply wasn’t much of a constraint. Furthermore, as the monetary authorities in the U.S. are believed to be planning to wind-down the stimulus programme completely, speculative money may move out of oil. Falling crude oil prices are a boon for the Indian economy that heavily depends on imported oil - about 80% of its requirements. Falling crude oil prices would thus result in savings in foreign exchange outflow, which could help the country improve current account position. Furthermore, falling crude oil prices may also lessen the subsidy bill of the Government substantially, since about 1/4th of the total subsides are oil subsidies.

Also India appears to have built a solid war-chest...and thanks to sound RBI policies for that. RBI has been buying U.S. dollars relentlessly. From U.S. $277.2 billion in September 2013, the foreign exchange reserves have gone up to U.S. $317.85 billion as per the data released by the RBI recently. Such sound position has made India well equipped to fight possible outflows of U.S. dollar once the stimulus package ends in the U.S.

However, inflation yet seems to show some stickiness. Although fall in crude oil prices has lowered the risk, inflation in food articles appear to be exerting some upward pressure. While deficiency in southwest monsoon has narrowed substantially to 18% from 43% in June; it hasn’t done away with worries. You see, rainfall in agriculturally important areas of northwest has been abysmally low. Although the region is highly irrigated, crop would be affected at least to some extent.

So, what to expect?
PersonalFN is of the view that, recent buying by Franklin Templeton Mutual Fund highlights the change in sentiment of foreign investors. While this provides a sense that India’s sovereign rating could be upgraded, where everyone expect the Standard & Poor’s to upgrade country’s ratings from BBB- with a negative outlook; one needs to gauge the action holistically with all macroeconomic variables.

It is believed that, Franklin Templeton Mutual Fund diverted almost all proceeds it garnered by selling debt in other Asian market. The FIIs have almost exhausted their limit for buying Indian debt. Moreover, the Finance Minister had proposed in the budget a reduction in withholding tax for FIIs to 5% from 20% earlier. Going forward, inflation would remain the most important factor deciding the interest rate movement in India.

PersonalFN has been long holding its view that one shouldn’t speculate on the movement of interest rates in the economy. PersonalFN believes you shouldn’t invest more than 20% of the debt component of your portfolio in long term debt funds. If inflation falls, and Indian economy revives Indian debt might do well.

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