Where to put your money now: GOI bonds and equity

Investors in Indian assets are best invested in financial assets for the best returns going forward. The outlook for 10-year government of India bonds (GOI), the rupee (INR), Sensex and Nifty is highly positive, as many macroeconomic factors are turning favourable for these asset classes. In order of returns, bonds and rupee 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 percent in fiscal 2013-14

The global macro is favourable for Indian bonds and rupee. The ultra low interest rates in the economies of the 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 Bonds are trading at levels of 1.66 percent, 1.20 percent and 0.61 percent respectively, and such low yields do not offer much scope for returns from investing in safe haven bonds.

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[caption id=“attachment_743183” align=“alignleft” width=“380”] FIIs have invested around $5.5 billion in Indian debt in fiscal 2012-13. AFP[/caption]

The 10-year Indian government bond is trading at levels of 7.75 percent, a differential of 600 bps (6 percent) and above over the 10-year bonds yields of US, Germany and Japan. FIIs are buying Indian debt to take advantage of the higher yields offered by government and corporate bonds.

The Indian government is encouraging FIIs to invest in rupee-denominated debt with limits of $76 billion of which $25 billion is in government bonds and $51 billion in corporate bonds.

FIIs have invested around $5.5 billion in Indian debt in fiscal 2012-13 and going by the good response to the April 2013 FII government bond limit auction for$ 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.

The Reserve Bank of India (RBI) is widely expected to cut the repo rate by 25bps in its 3 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 percent 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 4,84,000 crore 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 percent levels and below in this fiscal. A 75 bps fall in 10-year government bond yields implies a return of over 12 percent on government bonds.

The rupee will strengthen by 10 percent against the Dollar

The rupee is trading at levels of Rs 54 to the Dollar. The highest level the pair touched was Rs 57.20 in June 2012. Rupee is trading up 5 percent from lows but is still down by 17 percent from levels seen in mid 2011. The rupee can appreciate by 10 percent in fiscal 2013-14 to reach levels of Rs 48.6 to the Dollar. The rupee 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 percent of GDP seen in 2012-13 to below 4 percent levels in fiscal 2013-14. The sharp fall in oil prices globally, which are down 12 percent over the last one year, is positive for India’s trade deficit, as oil imports constitute almost 35 percent of India’s total imports. The fall in gold, which is down 15 percent from the highs seen in 2012, will also have a positive impact on the country’s import bill, as it constitutes around 11 percent 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 $ 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.

A lower CAD and positive portfolio flows will help the rupee strengthen by 10 percent against the Dollar.

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 rupee. 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 percent in fiscal 2012-13 from growth rates of 8.4 percent seen a couple of years ago.

India’s economy is coming out of a phase of high inflation (inflation as measured by the Wholesale Price Index was trending at over 9 percent levels before coming off to 6 percent 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.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com, a web site for investors