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India fixed income: Standing tall amid rising uncertainties

With many parts of the world seeing downside risks to growth, India’s economic resilience is being regarded as a bright spot. Read the article to find out more about India fixed income investment opportunities.
28 April 2023
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    Key takeaways

    • With many parts of the world seeing downside risks to growth this year and with India’s economic resilience being regarded as a bright spot, investors in India bonds will potentially maintain a carry advantage over developed market and most emerging market bonds
    • 10-year government bonds currently yield 7.1 per cent. In the HSBC India Fixed Income strategy, the yield is improved with a well diversified portfolio while the average credit rating is maintained at investment grade
    • India’s solid economic growth outlook, a moderation in inflation and the end of the monetary tightening cycle in sight for both India and globally are positive support factors for India bonds
    • India has seen an increase in services exports in 2023. This should lead to a smaller current account deficit, which would in turn add to the INR strength. The high amount of accumulated foreign exchange reserves of USD 585 billion is also a strong anchor for the INR level
    • In the HSBC India Fixed Income strategy, we have been progressively reducing our underweight in duration in the INR onshore market considering that we are at or close to the peak of the rate hike cycle. Within INR government bonds, we prefer the 5-10 year tenor for better risk-reward opportunities

    What is the market outlook for the India bond market for the rest of the year?

    Pause in rate hikes after a year

    The picture for the India bond market, like other bond markets globally, has changed drastically just within the past twelve months. Since May 2022, the Reserve Bank of India (RBI) has hiked the policy repo rate in every Monetary Policy Committee (MPC) meeting except for the last one held on 6th of April when, unexpectedly, it decided to pause. After an aggregate increase of 250bp in the past year, the policy rate was kept unchanged at 6.50 per cent in the April meeting, with the RBI stating that it needs to assess the impact of the previous rate increases. As has been the stance since last May, the RBI will continue focus on withdrawal of accommodation to ensure that inflation aligns with the target while supporting growth. The RBI emphasized that keeping rates on hold is applicable only to the April meeting, indicating that there is no pivot. Instead, the central bank will continue to watch the evolving inflation and growth outlook and will take further action if required in the following meetings.

    The RBI marginally cut its inflation projection to 5.2 per cent for FY2024, versus the previous 5.3 per cent forecast. Despite the pause, the RBI stated that inflation remains above target. The central bank also pointed to India’s resilient economic activity, forecasting GDP to grow at 6.5 per cent for FY2024, which is marginally higher than the previous forecast of 6.4 per cent. Average crude oil price for the Indian basket has been assumed at USD 85/bbl from the earlier USD 95/bbl, which can be attributed to the forecast changes.

    What’s next?

    Despite defying the consensus view, it is not particularly surprising that the MPC decided to tread with caution given that we are nearing the peak of interest rates and that global markets are currently encountering a high level of uncertainties. With overnight rates having moved by over 300bp in the past year alone, it surely makes sense for the RBI to assess the impact of past actions and keep an eye on global financial markets over the coming months.

    India’s strong external sector and robust growth momentum, especially compared to the rest of the world, give enough space for the RBI to wait and take calibrated measures in the future if needed. In this context, even if the RBI were to hike by 25bp one more time, the impact may be limited if accompanied by a change in policy stance to neutral from “withdrawal of accommodation”. The next MPC meeting is set to take place in early June.

    Although, the MPC expects some moderation in the inflation prints going forward, it remains unwavering in aligning inflation with the target. It should be noted that following the April MPC meeting, headline CPI inflation for March came in at a 15-month low; at 5.66 per cent,1 inflation is now below the upper tolerance level and seems to support the RBI’s decision to hold rates.

    Aside from the RBI, a number of other central banks have also paused on rate hikes while expectations of hikes from the US Federal Reserve have moderated in recent months. We expect to see the India 10-year government bond yield consolidate around the 7.25 per cent level. Still, the bond market is expected to remain sensitive towards changes in global rates, central bank actions, and commodity prices, which could bring about volatility on either side.

    With global growth slowing down, investors in India bonds will potentially maintain a carry advantage over developed market and most emerging market bonds. Further, India’s resilient economic growth outlook, a moderation in inflation and the end of the monetary tightening cycle in sight for both India and globally are positive support factors for India bonds.

    What is the investment case for India bonds?

    Attractive valuations and diversification

    Indian bonds offer relatively attractive yields and can potentially provide much desired yield enhancement and diversification in a global bond portfolio. India’s 10-year government bonds yield an extra 3.6 per cent, 3.3 per cent and 4.6 per cent over its US, UK and German counterparts. India bonds even offer a yield pick up against a number of other major emerging markets (Figure 2). Another point supporting the diversification argument is the low correlation of only 0.15 between India bonds and global bonds over the last 10-year period.2

    In our HSBC India Fixed Income strategy, the portfolio yield is enhanced with diversified allocation, which consists of exposure to corporate bonds, in addition to government bonds. Importantly, the average credit rating of the strategy is of investment grade.

    Favourable economic growth dynamics

    With many parts of the world seeing downside risks to growth this year and with the added uncertainties caused by the banking issues in the US and Europe, India’s economic resilience is being regarded as a bright spot. The IMF is projecting India’s GDP to grow at 5.9 per cent this year and 6.3 per cent in 2024, making India the fastest growing major economy in the world. Moreover, the IMF estimates that India and China combined will make up about half of this year’s global growth. India’s keen focus on continuing structural economic reforms and realising efficiencies will also be key to the economy’s medium term development.

    Relative strength in the currency

    The INR has seen an appreciation of 1.0 per cent against the USD since the beginning of the year.3 India’s exports rely heavily on services exports (>9 per cent), which have been much stronger in 2023 as the economic recovery globally is driven by services. This would support a smaller current account deficit in FY2024, which will add to the INR strength. 

    The high amount of accumulated foreign exchange reserves of USD 585 billion, which can cover 9.4 months of imports, is also a strong anchor for the INR level.4 It should be noted that the INR was less volatile than other major currencies during the 2022 episode of USD strength and beyond (Figure 3). Meanwhile, the currency is being supported by the return of foreign investors into Indian equities, which saw net foreign inflows turning positive in March and April. India’s increase in net services exports, narrowing trade deficit, continued USD weakness, and attractive fundamentals in the medium term should continue to support the INR.

    Large and liquid bond market and eligibility for global index inclusion

    Global investors can gain exposure to India’s expanding opportunities by investing in its sizable and liquid domestic bond market, which is now sized at USD 2.3 trillion.5 India is on the watch list to be potentially considered for inclusion in the FTSE Emerging Markets Government Bond Index (EMGBI). In March 2023, FTSE announced its decision to keep India on the watch list, citing investor feedback on Foreign Portfolio Investor (FPI) registration efficiency as one of the areas for improvement. Dialogue between FTSE and the RBI will continue. Indeed, there are restrictions on foreign investment in India’s domestic bonds, but there have been changes in recent years that have facilitated greater foreign investor access, particularly with 2020’s introduction of the Fully Accessible Route (FAR) – which does not impose FPI limits on investments in certain government securities. Any measure taken towards facilitating global index inclusion could be beneficial for foreign portfolio inflows into India bonds.

     

    How is HSBC AM’s India fixed income strategy positioned given the market outlook?

    The HSBC India Fixed Income strategy has maintained its investment grade credit rating, while aiming to achieve a competitive yield, currently at 7.5 per cent. The portfolio holds a combination of government and quasi-sovereign bonds as well as high quality corporate bonds.

    We maintain an underweight in duration, with a preference for government bonds over corporate bonds that trade on tight spreads. With the RBI keeping rates on hold in the April MPC meeting and considering that we are at or close to the peak of the rate hike cycle, we have been progressively reducing the underweight in duration in the INR onshore market. We continue to allocate over half of the portfolio in INR government bonds and prefer the 5-10 year tenor for better risk-reward opportunities.

    In the offshore space, as US Treasuries have been more volatile, this segment needs to be used cautiously. However, we have added exposure to USD bonds on the back of attractive yields.

    Over a decade ago, we launched one of the first UCITS products investing in India bonds as a standalone strategy. Since 2012, we have been providing a way for global investors to access the India domestic bond market, which still has a degree of restrictions imposed on foreign participation. We provide global investors the opportunity to access high yields in a relatively uncorrelated and large emerging market. Our strategy continues to operate under a robust investment process and diligent credit selection. These are processes that enable us to construct a diversified portfolio and implement a strategic allocation that potentially improves risk adjusted returns.

    Note 1: Source is Bloomberg as of April 2023
    Note 2: Uses Markit iBoxx ALBI India Total Return Index and Bloomberg Barclays Global Aggregate Index, based on monthly returns over the 10-year period as of 31 March 2023.
    Note 3: Bloomberg as of 24 April 2023. 
    Note 4: Source for foreign exchange reserves is Reserve Bank of India as of 7 April 2023; source for import cover is CEIC as of February 2023.
    Note 5: Source is Reserve Bank of India, SEBI, as of 31 December 2022.
    Note 6: Source is HSBC Asset Management, based on gross yield to worst, as of 31 March 2023.
    Source: HSBC Asset Management, Bloomberg, Reserve Bank of India, 25 April 2023.

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