5 things that defined debt markets in 2018

Year 2018 started with prospects of higher interest rates in the economy. RBI had been pretty vocal about its concerns regarding inflation and its hawkish stance. We observed volatility in Indian debt market indicated by yield movement of 10-year G-sec. Yet, we are looking at the similar yield levels that we saw in January 2018.

Let’s take a look at what moved debt markets in 2018:

In the beginning of the year 2018, markets were expecting rate hikes of close to 75–100 bps till March’19. In April’18, market had factored in 25 basis point rate hike owing to which G-sec yields climbed up, and but it dropped when RBI didn’t deliver the rate hike. That is why we see a significant drop in the chart above. Later RBI delivered two rate hikes of 25 bps each consecutively in June & August. However, it still is lower than market expectations therefore we didn’t see a significant rise in G-sec yields.

Crude Oil prices kept the consumers on toes this year. Starting in March, we saw crude prices increasing rapidly owing to demand-supply imbalance. We import crude oil heavily and any change in its price starts impacting country’s balance sheets. Higher prices meant we had to pay higher dollars in order to purchase the same amount of oil. This means we spent more Rupee to purchase same amount of dollar. This scenario resulted in Indian rupee depreciating to as low at Rs 74 per dollar. This scenario scares the investors due to which we saw huge FPI outflows from debt markets in this year. The crude oil prices have now cooled down and we expect the PFI flows to reverse in the coming year.

Inflation is one crucial parameter which guides the interest rate regime in India. RBI expected inflation to rise in the year owing to high MSP (Minimum Support Prices) promised by government for kharif crops, estimated impact of an increase in house rent allowances (HRAs) for central government employees and high fuel prices. However, inflation kept surprising the economy positively throughout the year. Thanks to benign food inflation we saw month on month inflation levels staying below RBI’s projections. This kept a check on bond yields in the country.

Corporate bonds of Infrastructure Leasing & Finance Ltd were downgraded drastically in September’18 following a default. IL&FS Financial Services also defaulted on its debt & repaid post the due date. Several mutual fund schemes had exposure to IL&FS and its subsidiary companies. Owing to the series of downgrades, the prices of these corporate papers fell which was reflected in declining NAVs of MF schemes as well. This spooked foreign investors, as IL&FS corporate bonds were AAA rated i.e. of highest quality. This event pushed the bond yields higher in Indian debt market.

Post IL&FS fiasco, mutual funds faced huge redemptions as there was a rush to safer assets. DSP Mutual Fund was one of the key holders of these downgraded papers. Once these papers became illiquid (as there was no demand for such downgrading bonds) and redemptions increased, DSP Mutual Fund was forced to sell other holdings too. They sold Dewan Housing Finance NCD at a yield of 11% — way higher than the rate at which it was previously traded. It created a panic in the market as speculations rose on the financial health of DHFL. This led to a negative sentiment on the entire NBFC sector and hiked up the bond yields.

However, towards the end of the year, the yields have moderated and we can safely say that the credit event started by IL&FS is behind us.

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