Short Is Sweet in Rupee Bonds as Supply Flood Hits Longer Debt

  • Deutsche Bank recommends switching to notes due in 3-6 years
  • Short-tenor Indian debt has been outperforming this year

‘Short is sweet’ is the mantra at global banks advising investors on India’s sovereign-debt market.

Deutsche Bank AG and Standard Chartered Plc are among lenders favoring front-end notes amid bets that a banking system awash with cash will help keep short-term rates in check, even as rising supply and the central bank’s hawkish tone threaten to push up yields on longer-tenor securities.

Notes due in three-to-seven years have delivered the best total returns among different maturity baskets of rupee sovereign debt in 2017, indexes compiled by Bloomberg show. They lag those falling due between seven and 10 years, and beyond, when measuring the performance over a 12-month period.

“Ample system liquidity will ensure that front-end bonds remain supported by value buying to earn good carry,” said Vivek Rajpal, a rates strategist at Nomura Holdings Inc. in Singapore. “The end-of-easing-cycle dynamics will ensure that investors and traders shift from the long end to the short end of the curve.”

Foreign investors are pouring money into Indian government and corporate bonds, lured by one of Asia’s highest yields and the promise of more economic reforms by Prime Minister Narendra Modi. Their holdings as a percentage of total debt outstanding are the highest for securities due in 2020, 2021 and 2023, data from National Securities Depository Ltd. show.

Security (Coupon and maturity)Total Foreign Holding (INR billions)Foreign Holdings as Proportion of Total Outstanding
8.27% 2020137.918.9%
8.83% 2023141.717.1%
7.80% 202111116.8%
6.97% 2026 (current 10-year benchmark)15.62.1%
7.61% 203016.11.9%
7.06% 20463.61.6%

Source: NSDL data as on April 11

The Reserve Bank of India surprised markets by raising the reverse repurchase rate last week, after unexpectedly signaling an end to its monetary easing cycle in February. While the authority has said it would use a host of tools -- including open market sales of bonds -- to drain excess cash generated by the government’s demonetization decision, the move to so-called ‘neutral liquidity’ is expected to take several quarters.

Franklin Templeton Investments’ bulk purchases of bonds in the 2021-2023 segment last month only underpinned investors’ liking for the front-end trade. Overseas funds’ total investment in Indian government and corporate notes has jumped 539.5 billion rupees ($8.3 billion) so far this year, already making for the biggest inflows since 2014. Foreign funds are barred from investing in local debt with residual maturity of less than three years.

Liquidity is expected to remain in surplus for at least three to four quarters, said Gopikrishnan MS, Mumbai-based head of foreign exchange, rates and credit for South Asia at Standard Chartered.

Strategists at Deutsche Bank last week advised investors to switch to the three-to-six year part of the Indian government bond curve, arguing that securities in the 10-year segment are trading “very rich” and bulk of the factors driving their outperformance are likely behind us now.

Click here to read more about factors impacting longer bonds’ performance.

“The front-end offers value because we are looking at a long period of easy liquidity and no rate action,” said Piyush Wadhwa, head of rates trading at IDFC Bank Ltd. in Mumbai. “This part of the curve offers good carry and roll down in this scenario.”

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