Investors in Indian assets are best invested in financial assets for the best returns going forward. The outlook for Ten Year GOI, INR, Sensex and Nifty is highly positive, as many macro economic factors are turning favourable for these asset classes. In order of returns, bonds and INR will deliver strong returns in the next one year while equities will tend to surge post 2014 general elections.
Indian government bonds are likely to return over 12% in fiscal 2013-14
The global macro is favourable for Indian bonds and the INR. The ultra low interest rates in economies of US, Germany and Japan coupled with asset purchases by the respective central banks are leading to a search for yields by global investors. Ten year US Treasuries, German Bunds and Japanese Government Bond are trading at levels of 1.66%, 1.20% and 0.61% respectively and such low yields do not offer much scope for returns from investing in safe haven bonds.
The ten year Indian government bond is trading at levels of 7.75%, a differential of 600bps and above over the ten year bonds yields of US, Germany and Japan. FII’s are buying Indian debt to take advantage of the higher yields offered by government and corporate bonds. Indian government is encouraging FIIs to invest in INR denominated debt with limits of USD 76 billion of which USD 25 billion is in government bonds and USD 51 billion is in corporate bonds.
FII’s have invested around USD 5.5 billion in Indian Debt in fiscal 2012-13 and going by the good response to the April 2013 FII government bond limit auction for USD 5.3 billion, where the full limits were taken up, it is likely that FIIs will continue to buy Indian debt in fiscal 2013-14.
RBI is widely expected to cut the repo rate by 25bps (we at Investors are Idiots.com are arguing that they will cut by 50bps) in its 3rd May 2013 annual monetary policy statement. Repo rate cuts by the RBI is positive for bond yields trending down as it signals an easing monetary policy stance.
The Finance Minister is confident of ending fiscal 2013-14 with a lower than budgeted fiscal deficit of 4.8% of GDP. A lower fiscal deficit could imply lower government borrowing leading to less pressure on the market to absorb government bond supply. The government is scheduled to borrow Rs 484,000 crores net in fiscal 2013-14 and any reduction in this borrowing in a positive interest rate environment can drive down bond yields sharply.
RBI rate cuts coupled with FII demand and local investor demand by banks, primary dealers, mutual funds and insurance companies and with a fiscal deficit under control, bond yields are likely to be driven down to 7% levels and below in this fiscal. A 75bps fall in ten year government bond yields implies a return of over 12% on government bonds.
The INR will strengthen by 10% against the USD
The INR is trading at levels of Rs 54 to the USD. The highest level the pair touched was Rs 57.20 in June 2012. INR is trading up 5% from lows but is still down by 17% from levels seen in mid 2011. The INR can appreciate by 10% in fiscal 2013-14 to reach levels of Rs 48.6 to the USD. The INR will appreciate on the back of falling current account deficit and rising capital flows.
The current account deficit (CAD) is expected to come off from levels of 5.2% of GDP seen in 2012-13 to below 4% levels in fiscal 2013-14. The sharp fall in oil prices globally, which are down 12% over the last one year is positive for India’s trade deficit, as oil imports constitute almost 35% of India’s total imports. Fall in gold prices that are down 15% from highs seen in 2012 will also have a positive impact on the country’s import bill, as it constitutes around 11% of the total import bill.
Capital flows into debt and equity are likely to stay robust, continuing the trend seen in fiscal 2012-13. FIIs invested USD 28 billion in equities and debt last fiscal and given current trends of search for yields by global investors, FII flows are expected to be equally strong this fiscal.
Lower CAD and positive portfolio flows will help the INR strengthen by 10% against the USD.
Sensex and Nifty will do well this year but will surge post 2014 elections
Indian equities will benefit from the positive outlook for bonds and the INR. FIIs will continue to invest in equities on expectations of the economy coming out of an extremely low growth phase that saw GDP growth bottom out at 5% in fiscal 2012-13 from growth rates of 8.4% seen a couple of years ago. India’s economy is coming out of phase of high inflation (Inflation as measured by the Wholesale Price Index was trending at over 9% levels before coming off to 6% levels over the last couple of years) and slow growth. India’s economy may not recover quickly but equity markets will front run a growth in corporate sales and profitability even as the economy limps back to a stronger footing. The Sensex and Nifty will close 2013-14 with low double digit returns but once political uncertainty is over and if there is a reformist government at the centre, the indices are likely to surge post elections.
Global markets will continue to do well this year
Global equities led by the Nikkei with 45% returns over the last one year have performed well. Outlook for global equities continue to remain positive as US reaps the benefit of low interest rates and falling commodity prices. Japan equities are riding high on the back of a weakening Yen that is down 17% over the last one year. European equities are benefitting from falling risk perception in Eurozone debt with bond yields of debt ridden countries of Italy and Spain falling by over 200bps over the last eight months.
Positive outlook for global equities will filter into positive sentiments on the Sensex and Nifty.