Liquidity crunch looms for Indian bonds as IDFC recalls taper pain

Yet, India is better prepared than five years ago to endure a shock, Real yields are much higher, the economy is in better shape, and the central bank has a clear mandate to target inflation

A liquidity crunch is looming for India, and funding costs could jump for all but the strongest companies, according to Suyash Choudhary, who foresaw the surge in rates back in 2013.

Indian assets have become less attractive to overseas funds amid tighter global liquidity, said Choudhary, head of fixed income at IDFC Asset Management Co. To mitigate the risk, he is stuffing his portfolios with sovereign paper and triple-A rated corporate debt, while selling bonds with weaker ratings.

“Call it a tail risk, but it is a risk you can’t ignore anymore given the confluence of events: tighter dollar liquidity, geopolitical risks and incremental deterioration in India’s macro,” he said in an interview in Mumbai. “It just looks like something waiting to happen. Spreads are too thin in India. They have to expand.”

Borrowing costs may climb 40 to 50 basis points this fiscal year, compared with a 100-basis point decline in the previous period, as bad loans at state banks curb lending and global funds sell down holdings, according to rating agency CRISIL Ltd. Investment-grade notes from India has underperformed those from China, and new supply runs the risk of higher pricing as investors have become more cautious, Citigroup Inc. said this month.

This may be the year when some firms face a shock when refinancing as investors shun illiquid paper, said Choudhary, who manages funds with $1.9 billion worth of assets.

Choudhary’s biggest fund -- IDFC Bond Short Term Fund -- has returned 4.6 per cent in the past year, beating 59 per cent of its peers, data compiled by Bloomberg show. The entire bond holding there was in triple-A paper such as Rural Electrification Corp Ltd and HDFC Ltd, according to its latest disclosure.

Cash Call

Being cautious has paid off for Choudhary.

Convinced that local borrowing costs were heading up with India’s unsustainable current-account deficit, he moved to cash at the start of 2013. While borrowing costs fell initially, the call presaged the contagion from the taper tantrum that drove the benchmark yield past 9 per cent and sent the rupee tumbling along with regional currencies.

The rout in local bond prices over the past year on increasing fears of the government missing its fiscal deficit target, surging crude prices, and a central bank that has started to tighten has given him a sense of deja vu.

Yields are up 44 basis points so far in 2018, while global funds have net sold $6.4 billion of bonds.

Yet, India is better prepared than five years ago to endure a shock, Choudhary said. Real yields are much higher, the economy is in better shape, and the central bank has a clear mandate to target inflation, he said.

Besides, yields may already be at the top-end of their range should the Reserve Bank of India engage in a shallow rate-hike cycle, and replenish liquidity by more open market bond purchases, he said. The central bank may need to spend Rs 1 trillion in the six months to March to buy debt, he said.

“We obviously find relative value in the front-end of the yield curve -- largely four-to six-year government bonds,” he said. “That’s really our core overweight.”