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Home > Knowledge Centre > Debt Opportunity in India

Debt Opportunity in India

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The year 2008 saw the global economies entering a recession which hit the developed economies worldwide and had a limited but significant impact on developing economies as well.

US - Real GDP Growth*	Eurozone - Real GDP Growth*
Japan - Real GDP Growth*	China - Real GDP*
Russia - Real GDP*
*Source: Bloomberg

With governments worldwide announcing various stimulus packagesto provide an impetus to their economies, the central banks across the globe have shown their intent in fighting the current recessionary economic environment as well. Central banks have cut interest rates and it is likely that we could see zero bound rate regimes in most of the developed world along with steep deficit financed fiscal stimulus. Given the slump in housing markets and continuous deleveraging in G-7 economies, inflation is likely to remain subdued.

Source: Bloomberg

US Fed Target Rate*

*Source: Bloomberg

The emerging world’s policy response could be as sharp as that of the developed world (helped by lower commodity prices), though they do not face the same credit headwinds that are constraining the developed world’s growth. Thus, countries such as India may gain prominence in the world economy with higher share in world GDP and capital allocation for investments.

The story in India so far

With inflation off its peak in India and expectations that it will moderate further, thanks to a fall in prices of crude oil and commodities, interest rates may fall further. With the GDP growth rate slowing significantly to around 7% levels (Source - CSO estimates) in the Financial Year ending March 31, 2009, and with the Index of Industrial Production indicating a slowdown, the Reserve Bank of India (RBI) is likely to pursue a loose monetary policy and is expected to further cut interest rates in the near future to stimulate growth and to keep liquidity comfortable.

Source: Bloomberg

Source: Bloomberg

With inflationary pressures abating and the overriding need being that of stimulating growth, the RBI has eased money supply in the banking system and reduced interest rates, triggering a major rally in gilts in the latter part of calendar year 2008. . The yield on the 10-year Benchmark Gilt fell from 8.68% on September 1, 2008 to 5.35% on January 2, 2009 (Source: Bloomberg). Gilt and long term corporate bond funds were among the best performing category of mutual funds in India in 2008. Fixed income funds (including gilt funds) have already attracted large inflows - over $1 billion in December 2008 itself. (Source – Securities and Exchange Board of India, 31st December, 2008).

Going forward

The scenario in 2009 is expected to resemble that during 2001-03, when, post the dotcom bust, the Reserve Bank of India reduced interest rates in a bid to boost economic growth. In the current environment of declining inflation and subdued industrial growth, we expect the soft interest rate regime to continue. Therefore, corporate bond yields are likely to soften further in 2009, especially at the shorter end of the yield curve. It is believed that funds investing in shorter maturity papers (1 to 3 years) would carry lower interest rate risk for two reasons. First, the expected reduction in short term rates by the RBI could subdue yields at the short end. Second, in the event that government borrowing increases yields at the long end of the yield curve, the impact on yields is likely to be less at the short end of the curve.  However, while the volatility and risk at the long end of the yield curve is likely to be greater, in the event of interest rates softening, the returns from funds investing in long dated bonds can also be significantly higher.

With economic conditions expected to be difficult for the rest of the year, there is little chance of the central bank raising interest rates in the economy. Also, while the yield on government securities has fallen in line with the RBI's rate cuts, credit spreads between gilts and AAA rated (rated by Indian rating agencies) corporate bond paper are however, still in the region of about 300 bps, much higher than historical levels. There is therefore scope for contraction in Corporate bond spreads over time towards historic average levels.

The debt opportunity in India was hitherto closed to the foreign investor. The RBI has recently opened up this asset class for Foreign Institutional Investors (FIIs) by increasing the investment limits for FIIs in corporate debt from $6 bn to $15 bn.

Conclusion

In the current re­cessionary scenario, opportunities for investments are limited and fraught with risk. In such a backdrop, an investor's choices with regard to alternative invest­ment avenues are restricted and involve uncertainty. Investment in Indian debt and Indian debt funds throws up an interesting opportunity for the international investor.

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