10-Y Yield Slips on Index Talks, Weaker Oil

Analysis of India’s Potential Inclusion in Bloomberg and JPMorgan Emerging Market Bond Indexes

Source and Citation: Original reporting from ET Bureau article published on January 10, 2024.

Analysis for Layman

The article explores the possibility of India’s government bonds being included in major emerging market bond indexes monitored by global investors, specifically those maintained by financial data providers Bloomberg and JPMorgan. The significance lies in the potential attraction of billions of foreign dollars into India’s bond market, thereby reducing the country’s borrowing costs.

In simpler terms, if global investors purchase more Indian bonds, the increased demand tends to raise bond prices, causing yields (returns) to fall. This has already been observed in the recent drop in the 10-year benchmark bond yield due to optimism surrounding the possible index inclusion. Lower government bond yields have broader implications, translating to lower interest rates for banks and companies seeking funds.

Impact on Retail Investors

Retail investors can benefit from index inclusion in several ways:

1. Lower Interest Rates: Cheaper loans for households, autos, and personal use as banks pass on their reduced borrowing costs, leading to higher disposable incomes.
2. Better Fixed Deposit Rates: Banks paying higher interest rates on retail deposits due to lower funding costs, potentially resulting in 50-100 basis points higher FD rates over the next year.
3. Stronger Rupee: Inflows of foreign capital can stabilize the Indian Rupee against the US Dollar, controlling import costs and inflation, ultimately benefiting the middle class.
4. Higher Bank Profits: Private sector banks relying heavily on wholesale funding could see expanded margins due to lower bond yields, potentially boosting their share prices.

Retail investors are advised to accumulate quality banking stocks during market dips for potential gains.

Impact on Industries

Industries that stand to benefit from index inclusion and lower bond yields include:

1. Banking: Public and private sector banks could see lower funding costs, with potential margin expansion.
2. Infrastructure: Savings on interest costs for entities like NHAI and Power Grid, providing room for capital expenditure. Suggested stocks include NTPC, Power Grid, and L&T.
3. Real Estate: Cheaper home loans could revive housing sales, benefiting developers like Godrej, Oberoi, and Sobha. Stocks such as DLF and Prestige are also considered good bets.
4. Autos: Savings on interest could boost margins for companies like Maruti and M&M, with increased demand from cheaper auto loans.
5. Consumer Discretionary: Lower inflation and rates contribute to India’s long-term consumption story. Favorable stocks include Titan and Asian Paints.

However, industries negatively impacted include IT services, pharmaceuticals, and telecom due to a stronger Rupee affecting USD earnings.

Long Term Benefits & Negatives

Over 3-5 years, index inclusion offers major structural positives:

1. Foreign Inflows: Potential inflow of $25-30 billion to depress the 10-year yield, lowering costs economy-wide.
2. Corporate Capex Revival: Cheaper funding costs could boost manufacturing and jobs.
3. Savings on Oil Subsidies: A stable Rupee may keep the crude import bill in check, despite global volatility.
4. Lower Rates: Better transmission aids financial savings and inclusion, supporting RBI’s medium-term 5% CPI target.

Negatives are limited, including modest erosion of export competitiveness and potential challenges for IT services majors.

Short Term Benefits & Negatives

Over the next 6-12 months, inclusion offers tangible gains:

1. Inflows: $5-10 billion inflows to compress the 10-year yield, boosting Net Interest Margins (NIMs).
2. Lower Loan Rates: Retail and corporate loan rates could fall, surging demand for autos and mortgages.
3. Capex Revival: Visible by H2 2024 across infrastructure and manufacturing sectors.
4. INR Stability: The Indian Rupee may strengthen against the USD, aiding inflation control.

Negatives include export-oriented sectors enduring margin compression and relative underperformance of Pharma and IT services stocks.

Company Impact Analysis: Falling Bond Yields in India

Indian Companies:

Potential Gainers (5):

• Interest-Sensitive Sectors: Companies in sectors like infrastructure, construction, real estate, and automobiles could benefit from lower borrowing costs due to falling bond yields. This could lead to increased investments and project expansions, boosting their revenue and profitability.
• Debt-Heavy Companies: Companies with high debt levels can potentially refinance their loans at lower interest rates, reducing their financial burden and improving their creditworthiness. This could benefit companies across various sectors.
• Banks and Non-Banking Financial Companies (NBFCs): While lower yields might put pressure on their net interest margins, increased access to cheaper funds could benefit their lending activities and overall economic growth.
• Consumer Durables Companies: Lower borrowing costs could lead to reduced consumer loan interest rates, boosting demand for consumer durables like refrigerators, washing machines, and air conditioners.
• Government Infrastructure Projects: Lower government borrowing costs might lead to increased budgetary allocation for infrastructure projects, indirectly benefiting companies involved in construction, materials, and engineering.

Potential Losers (5):

• Fixed Income Funds and Portfolio Managers: Falling bond yields can negatively impact the returns of fixed income funds and portfolios, potentially leading to reduced investor interest and outflows.
• Companies Reliant on High Yields: Certain companies, like those in the power sector, might see their return on investments affected by lower yields on their existing bonds.
• Exporters: Falling bond yields could lead to a stronger rupee, potentially impacting the competitiveness of export-oriented companies.
• Senior Citizens and Retirees: Individuals relying on fixed income from government bonds or corporate deposits might see lower returns on their investments.
• Short-Term Debt Investors: Investors expecting higher returns from short-term debt instruments might be disappointed by the declining yields.

Global Companies:

Potential Gainers (5):

• Global Investment Firms: Increased foreign investment in Indian bonds due to index inclusion could benefit global investment firms with expertise in emerging markets.
• Foreign Bond Issuers: Lower borrowing costs in India could attract foreign companies to issue bonds in the Indian market, potentially offering more investment options to global investors.
• Companies with Indian Operations: Global companies with significant investments or operations in India could benefit from a stronger rupee and potentially lower operating costs.
• Commodity Exporters to India: Falling oil prices due to the mentioned factor could benefit global oil exporters, though the impact might be limited.
• Emerging Market Index Funds: Inclusion of Indian bonds in major emerging market indices could attract more passive investment into the Indian market, benefiting companies included in those indices.

Potential Losers (5):

• Global Bond Investors Seeking Higher Yields: Investors looking for higher returns from emerging market bonds might be less attracted to India if yields continue to decline.
• Global Exporters Facing Rupee Appreciation: Global companies exporting to India might face challenges from a stronger rupee, making their products less competitive.
• Short-Term Global Portfolio Managers: Similar to Indian investors, global portfolio managers focused on short-term debt instruments might find declining yields in India less attractive.
• Global Currency Hedge Funds: Opportunities for currency hedging activities involving the Indian rupee might decrease with its potential appreciation.
• Companies Reliant on Global Commodity Prices: While oil prices are mentioned to decrease, this might not necessarily benefit all commodity exporters and could depend on various market factors.

Market Sentiment:

The news of falling bond yields is likely to have a positive impact on market sentiment in India, particularly for interest-sensitive sectors and companies with high debt levels. However, some segments like fixed income funds and exporters might face challenges. Globally, the impact could be mixed, with opportunities for increased investment in India alongside potential concerns for investors seeking higher yields or facing currency appreciation. The overall sentiment will depend on further developments and future changes in bond yields.

Note: This analysis is based on the limited information provided in the news article. Further research and analysis would be required for a more comprehensive understanding of the potential impacts.