Podcast 27th December 2013
Transcript of Podcast
The year 2014 will see strong FII flows in INR bonds. The reason is that on an absolute as well as relative basis, INR bonds offer good return potential for FIIs. FII’s have a limit of USD 81 billion for investments in INR bonds and have invested around USD 24 billion as of December 2013.
On an absolute basis, the yield differentials between global and domestic rates are high. Central Bank policy rates in the US, Eurozone and Japan are at levels of 0% to 0.25% while RBI policy rates are at 7.75% levels. Low policy rates in USD/ Euro and JPY currencies are keeping yields at levels of 0.1% to 3% in the three months to ten year maturity scale. Highest yields are found in the US with ten year bond yields at 3% levels and lowest yields are found in Japan with ten year bond yields at 1.7% levels.
INR yields are at levels of 8.7% to 9% across the three month to ten year maturity scale. Hence yield differentials between USD/Euro/JPY and INR are at absolute levels of 600bps to 850bps. Given that the Fed, ECB and Bank of Japan have pledged to keep rates at all time lows well into 2015, global bond investors will be forced to look at higher yields offered by INR bonds.
The issue of currency risk is what is preventing FIIs from coming wholeheartedly into INR bonds. The INR is down 13% against the USD in calendar year 2013 and high forward premia of around 8.5% is preventing FIIs from capturing yield differentials that is available on INR bonds. However given that outlook for INR is more positive than negative in 2014 on the back of a 30% fall in current account deficit, USD 34 billion inflows through FCNR B deposits and bank borrowings and strong inflows of USD 8.5 billion into equities since September 2013 it will be a matter of time before FIIs start receiving the high forward premia offered in the INR.
FII s becoming positive on the INR would lead to strength in the currency as well as bring down forward premia rates. Strong INR coupled with falling forward premia rates will make INR bonds attractive to FIIs leading to strong inflows into the debt market. FIIs have invested close to USD 1 billion into INR bonds in December 2013 and this trend is likely to continue in 2014.
On a relative basis the macros point to trades veering in the direction of selling low yield currencies and buying high yield currencies. The US is seeing the Fed starting to lower amount of money that it is pumping into the system on the back of improved economic data. US ten year yields have backed up by 120bps in 2013 on the back of improvement in the US economy. German ten year Bund yields have risen by 50bps in 2013 as markets sold low yielding German bonds and bought into Spanish and Italian bonds that have seen ten year yields drop by 250bps to 300bps from highs. At levels of 4.1% to 4.2% Spanish and Italian bonds do not look attractive compared to yields of 3% and 1.9% on US and German bonds. Global investors will start to look at countries like India where yields are higher and the governments and central banks are trying to put the house back in order.
Be positive on INR Bonds in 2014.
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