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The Joy and Pain of Investing in India

February, 2018

Vikram Aggarwal, Assistant Fund Manager-Fixed Income, Jupiter Asset Management shares the experience of investing in India’s fixed income market.

Our experience investing in India’s fixed income market has been mixed – the attractiveness of the investment opportunity is clear but there are obstacles to accessing the market. Given our mandate as global fixed income investors, we find India offers one of the most attractive macroeconomic environments. We have invested in Indian-rupee fixed income instruments since 2014 and this has provided outsized returns versus comparable opportunities.We were initially attracted to the investment by the prospect of a reforming government promising to improve the fiscal and external account metrics. This has been achieved and inflation has moderated, allowing benchmark interest rate cuts that have spurred attractive total returns for our investment. The attractive returns, however, have been offset by several limitations to the market.

The Indian government bond (IGB) market is very deep in size and we have found good two-way liquidity. This liquidity, however, can quickly fall away when attempting to trade quasi-sovereign bonds or privately-owned-corporate bonds. Even though there are a high number of sell-side brokers domestically who market-make these securities, the market for credit-risky instruments is still in its infancy. One reason for this is that local investor demand for these instruments is small and the number of domestic credit-focused mutual funds is still growing. In addition, we have found that the spread premium offered for moving down the credit-quality spectrum is low compared to other local-currency bond markets. There are a number of fundamentally attractive, privately-owned top corporate issuers in India. We do not find the spread premium offered by many of these companies attractive enough to warrant investing in their bonds. Furthermore, such companies are often unrealistic in their yield targets when issuing bonds, misunderstanding the premium required to borrow larger amounts. The result for us is a portfolio that is heavy on sovereign risk but light on credit-specific risk. Having said this, one sector in which we do feel that the spreads adequately compensate investors is the housing finance industry in India. We have invested in what we believe to be high quality housing finance companies. The outlook for the sector is positive given the extremely low penetration of mortgage financing in India, by global standards. Spreads over IGB on offer are still 150bps plus, despite recent rating-agency upgrades, which we feel more than adequately compensates investors.

One of the main challenges of investing in India is the administrative burden that comes with setting up funds to invest locally. Even though the Reserve Bank of India has attempted to streamline the process in recent years, for example by establishing a centralised ‘KYC’ database, we still found the process cumbersome and lengthy. In our view, this remains one of the main reasons foreign investors do not invest in the Indian fixed income market. Another topic of regular discussion has been the quotas placed on foreign investor participation in both the local government and corporate markets. Even though these quotas are one of the main impediments to inclusion of Indian government bonds in global bond indices, I actually view them positively. A general concern for us when investing in local currency bonds is that a rapid capital outflow by foreign investors would risk a sharp depreciation of the currency in question. By limiting foreign investor participation to around 7.5% of the total debt outstanding, India is in a unique position in that it is relatively immune to global capital markets. Given the ongoing ‘grab for yield’ in global fixed income, and accompanying speculative flows into emerging markets, we find comfort in being invested in a market that may be less impacted in a downside scenario.

The outlook for the Indian economy and fixed income market is one of the most optimistic relative to peers. Local regulators have been willing to adapt but in general have not been receptive, in our view, to investor feedback. The recent confusion regarding ‘masala bond’ issuance and whether such bonds were to be included in the foreign investor quota is an example of a lack of policy direction. The ongoing discord between the central government and the central bank has not helped. Narendra Modi has been proactive in driving reforms for the real economy – we as investors await a similar approach to financial markets.

In order for India and its markets to prosper and fulfil the potential a willing and accommodating regulator is key.

Opinions expressed in the article are the author’s own.

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