U.S central bank (Fed), recently announced to end its rate hiking cycle and shrinking of its balance sheet on back of falling optimism over U.S economy. Last year remained a period of robust economic growth with major central bank withdrawing from QE and U.S was leading the way with for rate hikes.
Most Central banks have again turned dovish as growth concerns have surfaced. The US Fed decision to stop shrinking its Balance Sheet would mean that liquidity would remain at comfortable levels. It means that for Emerging Market (EMs) like India, foreign investment, particularly in bonds, could continue to flow. As a result, EM currencies may not face pressure to weaken and may rather gain.
Bond investors look for markets with high real interest rates; investment rating and reasonable fiscal deficit (<3.5-4%). The below scatter diagram No 1 shows the countries with their real interest rate & fiscal deficit % of GDP.
In the diagram above, green colored countries indicate highest investment grade between Aa2 to A1, orange colored countries indicate medium to lower medium investment grade between Baa to BBB- with high real interest rate (in excess of 3.5%) and reasonable fiscal deficit % of GDP (less than 3.5-4%). On the other hand red colored countries indicate non-investment and speculative grade which are below Ba1 and with lower real interest.
Within emerging markets, countries like India, Indonesia, Colombia and South Africa seems to be the countries in which bond investors are likely to invest. These countries have fiscal deficit below 4%; they have investment grade credit rating and offer real interest rate in excess of 3.5%. Since very few countries qualify for these parameters, bond investors have limited choices. India could be a favourite with its attractive 4.5% real interest rate (Difference of yield on GSec @ 7.5% and Inflation of 2.5-3%). Hence we feel that in 2019, USD inflows in Indian bond market could be at healthy levels, keeping INR weakness under check.
*Disclaimer: Best efforts have been made to present the analysis and data as correctly as possible. However, it is prone to errors and therefore clients are expected to do their own analysis, independent of what is shared above, before taking decisions. This is neither a solicitation nor a recommendation to Buy/Sell any currency. No representation is being made that any suggestion being made above will necessarily result into profits and principals/employees/