Informist, Tuesday, Jun 4, 2024
--abrdn Akintewe on poll: Don't see immediate change in FPI strategy
--CONTEXT: abrdn Asia sovereign debt head Akintewe's views in interview
--abrdn Akintewe: Strong fiscal performance structurally baked into econ
--abrdn Akintewe: Coalition govt can make progress on reforms
--abrdn Akintewe: Negotiating reforms with states may be tougher
--abrdn Akintewe: Risk of govt bringing back populist policies
--abrdn Akintewe: Subsidy spending may rise, bring down GDP growth
--abrdn Akintewe: FPIs don't worry about 10-20 bps fiscal slippage
--abrdn Akintewe: Fiscal slippage may be minimal despite coalition govt
--abrdn Akintewe: RBI could start easing policy by end of 2024
--abrdn Akintewe: See RBI policy rate at 5.0-5.5% in medium-term
--abrdn Akintewe: Upward revision in India rating outlook long overdue
--abrdn Akintewe: FY25 bond supply-demand dynamics still strong
--abrdn Akintewe: FPI registration in India still takes months
--abrdn Akintewe: Still backlog of FPIs that need gilt trade licence
--CONTEXT: India to be included in JP Morgan bond index Jun 28
--abrdn Akintewe: High FX-adjusted returns advantage of Indian bonds
--abrdn Akintewe: India bonds are much more like a structural trade
--abrdn Akintewe: Index inclusion won't make India bonds volatile yet
--abrdn Akintewe: India bond mkt still has logistical headaches
--abrdn Akintewe: Don't see ease of access reforms for bond mkt soon
--abrdn Akintewe: Running longer duration portfolio vs competitors
--abrdn Akintewe: Expect Indian yld curve to decline, remain flat
--abrdn Akintewe: Running India bond portfolio duration of over 7 years
--abrdn Akintewe: Supranational bonds attractive on net-to-tax basis
By Aaryan Khanna and Pratigya Vajpayee
MUMBAI/NEW DELHI – With voting trends suggesting that the Bharatiya Janata Party may return to power with a weaker political mandate, the bond market's thoughts immediately went to the possibility of populist spending. Contrary to the concerns of domestic investors, Kenneth Akintewe, abrdn's head of Asia sovereign debt, said that strong fiscal performance is structurally baked into the Indian economy, and so the strategy of foreign investors in India's debt may not immediately change following the election result.
"The growth and improvements in revenues that we've seen in the last few years, this election result doesn't necessarily impact that," Akintewe told Informist in an interview today. "It's just on the expenditure side, you may see more expenditure. Fiscal performance would be better than expected."
Akintewe was one of the earliest adopters of investing in India's sovereign bonds at abrdn, a UK-based asset manager that manages about $17 bln in debt across emerging markets. His comments come in the midst of a vote count in the world's largest democracy, with the BJP led by Prime Minister Narendra Modi likely to lose its majority on its own. The BJP is ahead in 240 constituencies, having won 224 seats so far, compared with its 303-seat outturn in 2019. The majority mark in India's lower house is 272 seats.
Exit polls on Saturday predicted a landslide victory for the BJP-led National Democratic Alliance, with a forecast of over 350-400 seats. According to the Election Commission of India, parties in the ruling alliance are leading in 291 seats, with a coalition government likely to take power after two terms of the BJP securing a majority on its own.
Even with a coalition government in place, fiscal slippage may be minimal, though there is a risk of India's general government debt not falling as much as with policy continuity. The pace of reforms may become more difficult, but is not going to grind to a halt as long as the BJP forms the government with its political allies, Akintewe said.
Moreover, foreign portfolio investors will not mind a fiscal slippage of 10-20 basis points incrementally as the government had exceeded expectations on that front in the current year, Akintewe said. Government data showed India's fiscal deficit as a percentage of GDP fell to 5.6% in 2023-24 (Apr-Mar), compared with 5.8% in the revised estimate and 5.9% of GDP in the Budget estimate. The Reserve Bank of India's record tax surplus transfer of 2.11 trln rupees in May also provides a buffer to the incoming political regime, he said.
"...I don't think this is going to necessarily change the way the market would perform. Obviously, what we're seeing is near-term, a lot of knee-jerk reactions, but once we're a couple of weeks or a couple of months out, it could look very different," Akintewe said. Domestic bonds had their worst day in eight months, with the 10-year benchmark gilt yield zooming 10 basis points to 7.04% today.
The fund manager expects India's sovereign yield curve to remain flat in the near-term, declining uniformly. This made him constructive on long-term gilts, maturing above seven years, to generate higher capital returns as yields go down. This is similar to domestic investors, which have increased their exposure to long-duration bonds over the last few months.
"The simple fact is inflation is coming down, and as we get into the end of this year, the Reserve Bank of India, in all likelihood, is going to be able to start easing policy," Akintewe said. The fund manager sees India's policy rate in the 5.0-5.5?nd over the medium-term, compared with the current policy repo rate of 6.50%.
The Singapore-based fund manager pointed to the logistical pitfalls that foreign investors have to traverse to register and trade in India's bonds, ahead of the country's inclusion in global bond indices later this month. The two-year registration process for his own fund a decade ago has now declined to a few months, which may still faze first-time bond tourists to India, he said. Additionally, FPIs have to pre-fund their trades in India's debt market, and set aside margins for the trade, hoops that no other emerging market asks investors to jump through.
"It would be good if they can just make this market a bit more like a 21st century bond market," Akintewe said with a smile. "The authorities are very well aware of this. And frankly, if they wanted to change it, they probably would have."
Passive inflows owing to India's inclusion in JP Morgan Government Bond Index – Emerging Markets and Bloomberg's local currency emerging market debt index are expected to total around $30 bln. These inflows are unlikely to generate too much volatility in the large and liquid domestic market, according to Akintewe.
"Bearing in mind that a lot of these investors are still going to be in the process of learning about India. So, your ability to be active is a little bit more limited," he said.
Following are edited excerpts from the wide-ranging interview with Akintewe's wish list on regulatory changes, how tax laws are restricting bond market volatility, and why an appreciating rupee may be bad for debt FPIs:
Q. Today was an eventful day for the markets. You have the election results coming in and so far it doesn't seem to be going the way markets have thought. If the BJP forms the government with the help of allies, is that cause for any rethink on India, or the strategy with respect to India?
A. It probably depends on how you look at it. Bearing in mind that for most of the time we've been looking at India from the first initial phases around 2014 when BJP first came into power.
I don't know if you remember the narrative back then, but a lot of the global press said that the BJP just had this landslide victory. And very quickly it was like, 'Why are we not seeing more reforms?' And it was just a very poor understanding of the construct of Indian politics: to get things done is very challenging, right?
Your party needs to be on your side. You've got to negotiate support through both the lower house and upper house of Parliament. And even after you do all that, you've got the over 30 states and union territories, the majority of which also have to support your reform proposals. So, very, very challenging environment for getting things done.
Now, in those initial days of the BJP, there were reforms happening, even though it was an extremely difficult environment to push through reforms.
So, on the one hand, I'll say even if we're moving slightly back towards that kind of environment, and what I mean by that kind of environment is they'd be most likely be a coalition government, so their (the BJP's) coalition parties would have to be supportive of the policies. It probably means they've had some loss of support in some of the key steps. So, when it comes to negotiating reform with the states, that may be a little bit more challenging.
But they've done this before. So, it doesn't necessarily mean everything comes to a grinding halt or whatever. Progress still can be made. It's just going to make it much more difficult.
So, I guess the risk that one naturally thinks about is as you start to look at why these outcomes may have happened. Actually, some of it may not necessarily be all that surprising.
You probably report on how well India has grown these high levels of growth that the economy is experiencing. But the reality on the ground is not everyone is benefiting from that growth, right?
Like the levels of unemployment in parts of the economy, difficulty in generating jobs, a lot of pressure on the rural sector, agricultural volatility. In a way, it's not surprising that there has been some sort of fallout as a result of these kinds of pressures.
The one risk will be that the government, in order to try and rectify some of these issues moving forward may have to go back on actually what we've kind of seen more recently, which has been a paring back of some of the more populist policies, reduction in subsidies and things like that.
When we're reporting on 8% GDP growth, a lot of that is because of the fact that subsidy spending collapsed. And so, net indirect taxes are very high enough key driver of the GDP numbers. If you take out the net indirect taxes, the GVA (gross value added) growth obviously is much lower.
So obviously that impact has been quite substantial. You may see that the government once again wants to provide some support to the rural sector. Subsidy spending goes back up. Spending on rural employment guarantees and things like that goes back up. As an investor in the bond market you'd be thinking about how that potentially impacts your fiscal performance.
The good news there is that fiscal performance has been so strong. And a lot of that fiscal performance is kind of structurally baked into the economy.
The growth and improvements in revenues that we've seen in the last few years, this election result doesn't necessarily impact that. We will continue to see strong fiscal performance in terms of revenues and the tax base. It's just on the expenditure side, you may see more expenditures. So, the government has a buffer. Fiscal performance would be better than expected.
Your starting point is actually like 5.6% fiscal deficit, targeting obviously 5.1% this year. And then obviously these much larger transfers coming from the Reserve Bank of India to the government. But there is actually a lot of faith built into the fiscal performance that would actually provide some room for slippage.
It's just that when we look to the medium and long term, where you want India to get its overall debt levels back down again, so moving away from 80% (general government) debt to GDP, it does kind of require this very consistent and consistent consolidation in the fiscal condition. You need state debts to come down, you need central debts to come down over a prolonged period of time in order to bring down those overall debt levels.
And if incrementally over the next few years you see a bit of fiscal slippage, consolidation happens but at a much, much slower pace. And so the ability of the country to bring down its debt levels becomes much more challenging.
It doesn't necessarily derail the country or anything like that, but it's just what could have been a very positive story of debt levels coming down and everything becoming fundamentally more secure becomes much more challenging for the government to achieve. But we have to wait and see if that's what's going to happen.
What we may find out is that even with a weaker fiscal position, we still have strong fiscal performance, and the government resorting to those kinds of policies, and so the fiscal slippage is actually relatively minimal. That could happen as well.
Q. But will this deter investors on going overweight on index, or impact flows emanating from the bond index inclusion.
A. No. Investors will probably still want to have passively at least a 10% weight on India's bond as it is 10% of the GBI-EM index.
And if you agree with the way we're thinking about the market, I don't think this is going to necessarily change the way the market would perform. Obviously, what we're seeing is near-term, a lot of knee-jerk reactions, but once we're a couple of weeks or a couple of months out, it could look very different. The simple fact is inflation is coming down, and as we get into the end of this year, the RBI, in all likelihood, is going to be able to start easing policy.
We've got ratings agencies that are finally getting around to looking at improving the outlook for India. It's very overdue. This should have happened a long time ago. They've been very, very slow to adjust, but that may pick up some momentum because we could see Fitch and Moody's not just improve their outlook, but we should move towards actual upgrades for India.
And like I said, there'll be traction in terms of fiscal performance. Given the strong fiscal performance and then given these incoming debt flows, all the actual supply-demand conditions for the bond market are still going to remain very strong going into next year. So I don't think this election result would sort of stop that from happening.
If anything, one would argue that this development in bonds is actually a good opportunity to enter the market. You're getting cheaper levels in the foreign exchange market and you're getting cheaper levels in the bonds as well.
Q. If there is a rejig of policy priorities by the new government, how forgiving or unforgiving will foreign investors be? Something like this conscious shift from welfare expenditure to capital expenditure reversing.
A. It depends on the impact on the macro fundamentals. If you're talking about fiscal slippage of 10 to 20 basis points, I don't think anyone really cares, right?
Because at the end of the day, to give the government credit, performance has been already much stronger than expected. Before the budget this year, some of the more credible sell-side analysts were expecting the government to set a fiscal deficit target of say 5.3-5.5% of GDP.
And not only was it set at 5.1%, but even last year's deficit was already almost at those levels, 5.6% of GDP. So, I mean, fiscal performance has already been pretty strong. So it would depend what the expense of fiscal performance is.
If the wheels really fall off and you're talking about 60 to 70 basis points of fiscal slippage that at the end, fiscal deficit is now going to be back to the 6% or something. Yeah, I'm sure there will be an impact because what you're basically saying is that the government's bond issuance target is going to necessarily have to be at much higher. And that results obviously in yields probably rising. Even with the RBI transfers and things like that, you will probably see yields rising.
But that would be some kind of downside scenario. It would be difficult to expect to see that kind of fiscal slippage. And we'll find out soon enough in the Budget by the new government.
Typically, on the other side of the election, you don't really see that. You don't see things changing necessarily all that quickly. It takes a little bit of time. So, we'll have to see how it plays out.
Q. When it comes to investing in India's fixed income, you've been here many years. What was the narrative that you were investing in then and how has the narrative changed over the years?
A. I mean, some of the narrative is actually still the same. Even though India itself is fundamentally different from 20 years ago. Why on earth as a foreign investor would you go to all that trouble 10, 15 years ago of figuring out how to invest in the market?
The local market should not be that you can invest, but the markets are not very big or liquid. So, that creates a challenge.
But that's a very different trait from something like India where particularly for the last 10, 12, 13 years, you have very strong economic narrative, a reform-oriented economy and set of policies. And at the same time you have this huge market. And I mean, there's aspects of the Indian market that you don't find in any other emerging market local currency bond market.
Most of the time when we're talking about investing in emerging market local currency bonds, really the only thing you can talk about is government bonds. Whereas in India, you've got this like half a trillion dollar corporate bond market that has a full range of different quality of companies from very good quality companies down to high yield companies.
So, not only can you buy government bonds, you can buy corporate bonds. And then you even have things like state debt and a few different levers of accessing the market. So, that's also really interesting from an investment point of view.
Now you can think about doing that as opposed to just playing with duration. So, these are some that we were wanting to invest in the Indian bond market.
I had faced a lot of resistance the first time I brought up the idea. I think there were a lot of raised eyebrows.
Obviously today when you make the case where it is much easier because everyone can see the strong fiscal performance, inflation coming down, and a whole long list of reforms. So, now there's less pushback.
And the other aspect of that is India is operating in a world that is quite volatile and where many countries are making a long list of mistakes. So you could see the challenges and a lot of the developed market economies. You can see even more challenge in many of the emerging economies.
So, India is doing things on its own. But when you look at it relative to what is happening in the rest of the world it's not a surprise that it's receiving a lot of focus. But more so on the equity side, I would say the debt market is probably still less well known.
Q. We've heard some investors are still facing trouble with the KYC (know your customer) process. How has that changed over the last few years, and are there challenges heading into India's global bond index inclusion?
A. In some ways it's difficult to answer that question because it's really specific to the person who's trying to get access.
So, what I mean by that is if you take us who've been investing in the market, if we need to get a license for, say, a new fund or something like that, our back office, our middle office have gone through this procedure many times. So, what forms and everything to look out for, they know all the pitfalls and the things that can cause holdups and difficulties and they know what to look out for. Whereas many of these new investors into the market, their middle offices, their back offices, they would have never gone through the operational logistics needed.
And so, as you go through the process, you can suddenly find that something was not submitted correctly and they get kicked back. Basically if you do everything correctly, then yes, you can maybe go through that process in one month. But what people have been finding is that it's actually taking several months to get the registration done.
On the surface level, it's certainly much better than it was when we initially started trying to do that. Even if it's going to be a few months, you can have some sense of a timeline whereas when we were trying to do it in the initial days, you really had no idea how it feels.
But still, this is a particular instance whereby these investors are going to find India being part of their indices from this month. And so, it's not going to be an ideal situation if it's going into their index and they can't invest in the market. That gives you a lot of active tracking risk and you may find you're underperforming your index because you don't have access to the market. And our understanding is that there's still quite a backlog of investors that need to get a license.
Q. What kind of a rate cut cycle do you see in India, and when do you expect it to start? Are there any competitors within emerging markets in Asia for FPI flows, such as Indonesia and Korea?
A. In some cases, these are just very different trades. The volatility of the Korean won is much higher than the Indian rupee. So you have to be pretty careful when you enter trades in that.
If you buy local currency bonds and hold the FX risk and you get the timing wrong, you could lose a lot of money in that market. So this is one advantage of taking positions in the India bond market. It's much more of a structural trade. You can put it in your portfolio and almost forget about it basically.
When you look at overall emerging market local currency markets over the last decade, these haven't actually added any value. Whereas over the last decade, the Indian local currency market, even taking into account the currency depreciation, has returned something like 60% at the index level. So that is the massive, massive difference in performance.
And it's when you break down, like what is driving that? Tax reforms, fiscal reforms are increasingly supporting the bond market. If we think about the medium-term outlook we still argue that fiscal situation should be supportive, plus will be an environment of lower inflation.
So if we achieve like a 4% inflation target, then the RBI doesn't need to have a policy rate that's 6% or anything close to that. Arguably in the medium term, you could see a policy rate that comes down to like a 5.0-5.5% level. Not this year. Maybe not even next year. But you can move back to that kind of environment where they're able to actually bring down the policy rates a bit lower.
So if you think about what that means for the term structure, it shifts down lower in the medium term. So that's obviously quite an attractive return. If you're buying now, you're getting 7% yields, and then potentially could have anything from 3% to 7% in capital gains coming from the capital, the capital returns that the bond yields move down as well.
A lot of rupee depreciation against the dollar recently was driven by having a very aggressive US federal hiking cycle. Whereas as we look forward, in all likelihood, even though it's happening later than expected, and may not be as aggressive as people expected, nevertheless, the Fed (US Federal Reserve) will begin cutting interest rates. And they will likely cut more than the RBI will be cutting rates.
So if you overlay things like a much smaller current account deficit, continued FDI inflows, we actually may be moving to an environment where we can start seeing rupee appreciating a little bit against the US dollar. We still don't think it'd be a massive amount of appreciation, just because, as you know, there is a tendency for the RBI to intervene. You rarely see massive appreciation of the rupee.
And to be honest, you don't really want to see that appreciation, because it kind of changes the dynamic of the Indian trade. With having this very low volatility in the currency, it becomes this very nice low volatility carry trade that you can have a structural allocation to the portfolio. But if you start to see more currency volatility and it behaves something more like a Korean won, then it's difficult to look at it on a structural basis. You have to be a bit more tactful about when you put the currency risk in your portfolio.
Q. One of the pluses about the Indian market was the low level of foreign investment. And now that is going to change. We will see initially a lot of allocation to India after the index inclusion, but does that also make India a more volatile market over the medium term?
A. Not over the medium term. Over the very long term, then, yeah, potentially you'll start to see that happening. But, I mean, it's a moving target.
So, the way investors invest is when a country goes into an index, what you typically see in the first instance is a relatively passive flow. Bearing in mind that a lot of these investors are still going to be in the process of learning about India, learning about how the trade is conducted. So, your ability to be active is a little bit more limited.
But what tends to happen is you have a pretty passive allocation to it. In the context of India, you just don't want to be underweighted because if it's outperforming the other countries in your index, then you're underperforming. So, at the very least, you just kind of want an indexed weight, maybe even a structural bias to be slightly overweight the India market.
Then once new investors into the market have got those positions, they probably won't actively trade the market. Another factor to think about as well is bearing in mind that the structure of the market kind of discourages high-frequency trading. There's obviously pretty punitive capital gains taxes. So, if you're buying and then selling at a profit within 12 months, you will bill yourself up to a lot of capital gains tax.
So you really need to move into an environment where the amount of foreign money in the market as a proportion of the overall market is considerably higher. And bearing in mind that the GBI-EM investor base, you're probably only talking about some $300 bln. So $30 bln as a proportion of trillion-dollar market.
Really what you'd have to talk about is probably some other index inclusion stories going through, like India becoming part of the Bloomberg Barclays Global Aggregate Index. So, you have there's about $4 trln of global client money that tracks that index.
So, you have a much larger pool of foreign money in the market, but you also have to get to the stage where that pool of money is becoming more active about how they manage money within the Indian market. And then you can start to see the risk characteristics change a little bit. You'll start to see correlations to other markets increase a little bit. You'll maybe see volatility pick up a little bit.
Of course, we have a test case for this exact situation, which comes from the Chinese market. Bear in mind, there’s been a fair bit of volatility in China. There have definitely been changes in exposure. But when you look at the volatility of the market, when you look at the correlations to other markets, you haven't really seen any meaningful change in these risk characteristics.
Q. As an offshore investor into India's debt market, what are the next policy changes you're looking forward to from the government and regulators?
A. I mean, it would be good if they can just make this market a bit more like a 21st century bond market. Like all these things, the margin requirements and pre-funding of trades. You don't have these things in any other markets. And it just results in these additional operational logistical headaches that you constantly have to monitor which you don't have in other bond markets. But the authorities are very well aware of this. And frankly, if they wanted to change it, they probably would have.
So, I don't expect any changes in this anytime soon. Obviously, the ideal situation would be to move the market towards Euroclear trading. That would make life for everyone just so much easier. You wouldn't have to go through separate sort of KYC (know your customer) where they're setting up counterparties and all these kinds of things. There'll be single window access.
The market gets very easy to access for a new investor. And you would already have your trading panel in place. That would be the ideal situation. But obviously, there's the domestic reasons why it's difficult for them to do that. So I wouldn't expect that to happen anytime soon.
At some point the tax situation becomes a bit of a problem. It's less of an issue now just because gross yields are quite high. But let's say we go through an easing cycle, and policy rates have come down by 50-100 bps. Then the gross yields will look less attractive. And yields net of 20% withholding tax will look much less attractive. So, you may see a stronger bias than what we maybe would have had in the past to then reallocate to other markets.
Arguably, that would be a reason for maybe bringing down the taxes and stuff. But I just don't think the authorities really care that much. At the end of the day, foreign investors are still relatively small. Even after all these inflows, foreign investors are relatively small components of the overall market.
Q. We've heard some new developments for green bond issuance and trading is underway at GIFT City, the IFSC in Gujarat. Are you tracking that space, and do you think such a zone with tax benefits will attract foreign bond investors?
A. That would be interesting. And these are the kind of things you see develop, like alternative access routes. There would obviously be interest in that. It's one of these things, however, it's a more complicated way of achieving the same result.
We've heard similar sort of comments made about that. And it's something we would obviously sort of look at what is being traded and what the tax impacts are.
Q. What range do you see the 10-year gilt yield in until December? What part of the Indian yield curve are you most constructive on?
A. Generally, we're running a longer duration portfolio than some of our competitor funds because we've been expecting that we'll move into the environment where the yield curve is going to decline. So, we think it will remain relatively flat.
Even though the curve is flat, all else being equal, we still want to have some higher sensitivity. So, generally, for us, we've been running a longer duration portfolio, in excess of seven years basically.
And in order to do that, we have to focus on bonds, in some cases, that have a maturity of 10 years or longer. When you're talking about the start of this year you actually saw some interesting opportunities. There was a bit of steepness in the curve towards the 2053, 2063 bonds, so a good time to build that exposure.
Since then, the curve in between the 10-year and those 30, 40-year bonds has flattened out. So, that was an interesting opportunity. We do also focus on bonds that are outside of the domestic bond markets.
I'm not sure how familiar you are with the SSA (Sovereign, supranational and agency) bond market. Because the way those bonds used to be priced was because they're free of tax, essentially, the pricing would be onshore bonds minus of the tax. And it should be trading somewhere around those levels.
But of late even on a gross of tax basis, you've got a lot of supranational bonds that are trading in line with or even in some cases above the onshore bonds. So, obviously, on a net-to-tax basis, those bonds are attractive. It's been kind of like difficult to ignore that market, so we also see some opportunities there.
But the maturity profile of those bonds and liquidity profile is very different from domestic bonds. They're not as big, not as liquid. The maturity only really goes out to around 10 years. So, if you're trying to build a longer duration portfolio, maybe only provide you some limited sort of opportunity.
But that's been an interesting avenue of getting India exposure without necessarily having to buy domestic bonds. And it's worth bearing in mind because that is an opportunity that global investors also have. So, if they don't want to invest in domestic bonds, they could also be buying supranational bonds. There's been a lot of issuance coming to that particular space. End
US$1 = 83.53 rupees
Informist Media Tel +91 (22) 6985-4000
Send comments to feedback@informistmedia.com
© Informist Media Pvt. Ltd. 2024. All rights reserved.