After the landslide victory of the BJP-led NDA in the general elections in May 2014, the equity markets have witnessed a very strong performance and are seeing significant FII flows.
Even as investors are super excited about equity markets, we would like to argue that bonds are looking equally attractive. Here is why we think so.
Why are Indian bonds looking attractive?
(i) Absolute yield
Indian 10-year yields (the conventional benchmark) continue to trade at close to their highest levels over the last decade. The chart shows the movement of the 10-year bonds in the last 10 years.
(ii) Relative value versus international bonds
Indian bonds offer a significant relative value opportunity at a time when central banks around the world are following unprecedented easy monetary policies. At the recently concluded meeting, the European Central Bank (ECB) made some landmark moves lowering deposit rates to a negative zone (minus 0.10 %). Other countries such as Japan are continuing with their measures to revive growth through Quantitative Easing (QE) and QE variants. Even as US winds down its QE programme, probability of a near-term rate hike appears weak.
The differential between INR and USD benchmark yields stands at close to 6.0% as on date. The UST is currently trading below its long-term average, while the Indian sovereign bonds are trading well above the long-term average.
(iii) Significant improvement in macro environment
Post August 2013, the domestic macro environment has undergone good improvement on most of the key parameters.
(a) Improving current account, stable INR
Following the curbs on gold imports and a fall in gold prices, there has been a significant improvement in the current account scenario. The CAD in FY 14 was the lowest in the last five years and March 2014 – CAD was the lowest in the last 20 quarters.
After remaining flat for a long period, the reserves have started growing. Post July 2013, FCNR deposits and FII flows have augmented reserves. As mentioned earlier, net flows into equity and debt aggregate over $17 billion y-t-d. In a bid to prevent the INR appreciating strongly, RBI has been mopping up most of the flows, which is reflected in an improving reserves position.
(b) Stable government and policy regime
Given the stability that the new government will have at the Centre, it can be expected to take some bold reforms to stimulate growth and overcome some of the policy inertia witnessed in the last