2020 has been a unprecedented yr on many accounts. It has been a yr of going through, studying and adapting to the unknown. It has modified human and societal conduct in a big manner. The style by which numerous markets have responded over the course of the yr would have altered investor conduct as effectively.

Mounted earnings buyers witnessed one other yr of blended efficiency throughout numerous classes. Rates of interest on financial institution deposits and returns on liquid and cash market funds continued to go down and now at ranges final seen throughout 2008 monetary disaster. Credit score threat funds had one more painful yr and in some instances worn out a big a part of buyers financial savings. Opposite to those, buyers in lengthy period and excessive credit score high quality bond funds loved one other yr of nice efficiency.

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The RBI continued it’s simple financial coverage by reducing coverage charges and infusing quite a lot of liquidity into the banking system. The coverage repo charge has been diminished by cumulative 115 foundation factors and the reverse repo charge by 155 foundation factors in 2020. This was after 135 foundation factors discount within the coverage charges within the final calendar yr. The coverage repo charge at present stands at 4.0% and the reverse repo charge at 3.35%

RBI’s motion on liquidity was much more aggressive. Liquidity surplus within the Banking system has been stored over ₹6 trillion for more often than not this yr. This excessive liquidity surplus has stored the brief time period cash market charges similar to 3 months treasury payments or PSU CP/ CDs under the reverse repo charge. At the moment the three month treasury payments and PSU CPs are quoting under 3.2%.

Going into 2021, the drivers of fastened earnings efficiency are prone to change. Within the final two years efficiency of the fastened earnings asset class was predominantly pushed by the RBI’s financial lodging. However now with inflation hovering above the coverage repo charge, room for additional charge cuts is probably not accessible.

We see following themes taking part in out within the subsequent yr:

Financial coverage normalization

In 2020 central banks throughout the globe have gone ‘all in’ to neutralize the financial ache attributable to the covid-19 pandemic. Going into 2021 the influence of the disaster is subsiding and the economic system is getting again on monitor. Nevertheless, the restoration continues to be at a nascent stage and would require continued coverage helps.

The RBI, in its October financial coverage, has dedicated to take care of an accommodative financial stance within the present fiscal yr and going into the following fiscal yr. Given the macro backdrop of fragile development restoration and sticky inflation development, the RBI could keep a established order on coverage charges within the subsequent yr. However, if development restoration sustains, its focus might shift in direction of coverage normalization and a gradual withdrawal of extra financial lodging.

Up to now, liquidity excesses has prompted macro instability and resulted in disaster. Uncontrollable inflationary pressures put up 2008 world monetary disaster and the latest credit score disaster within the bond and cash markets after the IL&FS collapse all have their roots linked to extra liquidity.

We anticipate the RBI to start normalization of financial coverage by the center of 2021. They may start by decreasing the quantity of extra liquidity. This might result in the coverage charge shifting from Reverse Repo to the Repo Price. In such a state of affairs, in a single day and brief time period rates of interest might start to rise. That is constructive for potential returns from liquid funds.

Fiscal consolidation roadmap

Identical to financial coverage, the federal government additionally stretched its fiscal place to cope with the disaster. Even earlier than this pandemic, consolidated fiscal deficit of heart and state authorities was at elevated ranges. Within the disaster it confronted a double whammy of decrease tax collections and an elevated spending on well being care and welfare.

Within the present fiscal yr 2020-21, heart’s fiscal deficit might rise to eight% of GDP whereas states might add about 5% of GDP. India’s public debt might leap to about 90% of GDP this yr. This is likely one of the highest amongst related rated rising economies.

A medium time period fiscal plan can be wanted to convey down the fiscal deficit and debt ranges to extra sustainable ranges. Authorities’s roadmap for fiscal consolidation may have bearing on the bond markets. Market will intently look ahead to cues within the funds for FY 2021-22 which might be offered in February 2021. Something larger than 6% FD/GDP would require assist from RBI, else charges are prone to transfer larger.

International Bond Index and International flows

Globally bond yields have come down. In a lot of the developed economies yields are near zero and even adverse. In comparison with this, the yield on Indian bonds appears enticing even after adjusting for potential INR depreciation.

Authorities can also be eager on attracting overseas capital into Indian debt. They’ve made needed adjustments within the guidelines for overseas investments to get into world bond indices. International investments in India bonds are actually under USD 40 bn. The potential limits accessible for funding is now upwards of USD 200 billion. Given the excessive world liquidity and low yields in developed economies, India might appeal to sizeable overseas inflows within the home bond markets. If occurs this might be a serious constructive for the bond markets.

Outlook

In 2021 bond yields might reverse their downward development and grind up in direction of the yr finish. Quick finish charges (as much as 3 years maturity) are at present priced aggressively as a consequence of extra liquidity thus carry most threat of reversal. Whereas the longer section could proceed to get the RBI’s assist from OMO purchases and twists. Thus the yield curve will doubtless flatten within the subsequent yr (brief time period charges transfer up greater than longer ends).

Mounted earnings buyers ought to acknowledge that the perfect of the bond market rally is now behind us. At the moment bond yields are at multi yr lows and scope for capital good points look restricted. Going into subsequent yr, buyers ought to decrease their return expectations from fastened earnings funds.

(The writer is the Fund Supervisor-Mounted Earnings, Quantum AMC. Views as expressed are his personal.)