Real Estate vs Fixed Deposits

Recently I came across an article on facebook regarding lack of viability of investing in real estate by taking loans: the article went so far as to say Only Builders, Banks gain when you take loan to invest in Realty.

Though I do not entirely disagree with the line of thought in the above article, there are some inaccuracies in the same like double counting the Initial cash in Fixed Deposit side etc. Anyways, below is my take on the realty vs a simple FD/RD:

As outlined in the outperformance matrix, Realty will outperform Fixed Deposits only if the appreciation in 5 years is greater than about 55%. There are assumptions about loan and fixed deposit rates - a tweak in those will impact the above matrix. However, the point to take home is that Real estate is worth the risk only if we see growth of >15% per year. Else, it is definitely not worth the price risk and liquidity risk.

Interesting Read: In World's Best-Run Economy, House Prices Keep Falling -- Because That's What House Prices Are Supposed To Do

Clear as Mud

Read a forwarded post on facebook  - "Clear as Mud" - written by one Aubrey Bailey on the state of confusion and militarism in the middle-east. Brilliantly put:

“Are you confused by what is going on in the Middle-East? Let me explain. We support the Iraqi government in its fight against Islamic State (IS/ISIL/ISIS). We don’t like IS but IS is supported by Saudi Arabia whom we do like. We don’t like President Assad in Syria. We support the fight against him, but not IS, which is also fighting against him.
“We don’t like Iran, but the Iranian government supports the Iraqi gov’t against IS. So, some of our friends support our enemies and some of our enemies are our friends, and some of our enemies are fighting our other enemies, whom we don’t want to lose, but we don’t our enemies who are fighting our enemies to win.
“If the people we want to defeat are defeated, they might be replaced by people we like even less. And, all this was started by us invading a country to drive out terrorists who weren’t actually there until we went in to drive them out – do you understand now?”

Source: http://www.davidicke.com/forum/showthread.php?t=282391

 

Tax Treatment of Debt Mutual Funds - Impact on Yields

In the current year's budget, the finance minister has changed the tax treatment of debt mutual funds considerably.  The following image from Economic Times highlights the changes succinctly:

This change, whether or not retrospective, would in effect kill the product FMP - Fixed Maturity Plans - as the sole selling point of the product was tax efficiency.  As Fixed Deposits become on par with FMPs with respect to tax treatment, the liquidity of FDs will overtake FMPs in popularity. 

The impact on Income funds owing to this tax change would not be as directly comprehensible or not as direct.  As per the latest available AMFI data, total investment of approx. INR 165000 Cr is in non-equity category for periods greater than 1 year. As about 90% of the INR 155000 Cr (after adjusting for Gold ETFs and Overseas Fund of Funds) is invested by Corporates and HNIs, it is fair to assume they are sufficiently tax aware and would be making switches for the proportion of investments they intend to hold less than 3 years. 

It is to be noted that corporates and HNIs look for capital gains (owing to price rises or easing yields) over and above interest income - or in other words, their intended holding period of investment and average maturity of the securities in their portfolio need not match: the former being sufficiently shorter. If there is a portfolio level asset shift is made, then a good amount of longer duration securities could be sold. In a nutshell, this could be sufficiently G-Sec and Corporate bond negative in the short term unless Government/RBI enable FIIs to participate in the market as their limits are now completely utilized and they cannot make incremental investments. MF holding of GSec is about INR 40000 CrINR 8000 Cr (based on total GSec+SDL+Tbill amount of INR 50L Cr and that MFs hold 0.17% of that) (Source: Finance Ministry)out of a total outstanding of close to INR 36 lac Crores. Hence, though the impact on GSec market is negative as some sections of  market currently portrays it to be. However, the major negative impact would be on the NCD and Corporate bond market.

The money that is currently in the liquid funds (approx. INR 1.30L Cr) can find their way to Equity arbitrage funds as the latter is treated on par with equity funds - 15% short term capital gains tax and long term capital gains tax of NIL. More importantly, the definition of long term is only 1 year as against the 3Y now for liquid funds. Whether the Equity arbitrage funds can manage to get the same returns with the increased corpus is a different discussion.

Bottomline of the Tax Revision of Debt MF: 

• Mildly Negative for G- T-Bills
• Negative for G_Secs, Corporate Bonds, CPs,and CDs
• Futures premium over spot in Equity might decline and may not be aligned to call rates in the short term.

Update: If there is a sunset clause to this notification, there could be accelerated redemption leading to sharp sell-off in G-Secs. Keep a look out for the Sunset clause, if indeed it comes bond yields can shoot sharply higher - I expect a barbell kind of a redemption pattern: one bout of redemption immediately on announcement and the second bout of redemption close to the sunset date. Sunset date earlier than 2015 would be significantly negative for G-Secs.

The most important charts from the terrific US jobs report

Interesting Charts on US Jobs Report

MIFOR-OIS Trade of June 2014

Avenues for Indian Financial Institutions to raise USD:

(1)    Direct Fund Raising in Global Markets

(2)    Fund Raising through Synthetic structure

Synthetic Structure Details

In this synthetic structure, they borrow INR in the Indian market at CD rates. They raise INR in any liquid tenors such as 3 Month or 1 Year Certificate of Deposits, reduce the risk of roll-overs by receiving MIBOR and hence immune to local rate swings, Swap the INR to USD at a spread over LIBOR.  The exact structure is that they enter in the market is an INR to USD Float-Float Swap wherein the local Financial institution pays 6M LIBOR+X and receives MIBOR. The synthetic structure would be a better alternative only if the cost is lower than the direct route after adjusting for basis risks.

Risk to the Synthetic Structure

Currency Risk: There is no incremental currency risk owing to the synthetic structure vis-à-vis the direct route as the FI is exposed to INR depreciation against USD equally in both the cases.

Basis Risk: The main basis risk run by the FI is with respect to the spread of CD rates over MIBOR at the times of roll-over. They can overcome this risk if direct 5Y INR money is raised. However, in the current month or in general, there was no major local bond issuance from the FIs/ PSU banks.

Rationale for the Trade

The Spread X would be a function of the difference between MIFOR and OIS levels of corresponding tenures. To arrive at the effective spread over 6M LIBOR, the spread of the bank’s CD over MIBOR needs to be added to X. The following chart highlights the direct USD fund raising rates (red line) versus the derived USD fund raising rates (blue lines). The direct USD fund raising rate is estimated using SBI 5Y CDS spread, US 5Y treasury yield and US 5Y IRS. The derived USD fund raising rate is estimated using spread of OIS over MIFOR and 1Y PSU CD spread over MIBOR.

It can be observed that the funding cost of the synthetic structure is, in general, moderately lower than the direct funding cost – likely attributable to the basis risk. The synthetic USD funding rate was about 6mL + 100 in the beginning of June 2014 and it dipped close to 6mL + 25 in the first week of June – exact time when this trade started to kick in the market. It is to be noted that SBI raised USD 1.25 Bio in April 2014 with close to USD 750 Mio in 5Y tenure at US5YT+205 or equivalently 6mL+185. They went for direct fund raising at 6mL+185 when the synthetic cost was in the similar range (6mL+150 to 6mL+200 in the Jan-Mar qtr); however in June the derived cost was significantly lower (by about 100 bps) and close to the lowest seen in the last 2 years.

A natural question arises as to whether this trade happened in October 2013 – as the difference between synthetic funding and direct funding was larger and that structured funding was happening at sub 6mL+100 levels.An educated guess would  be that October 2013 was a period of RBI firefighting to get in more USD and the said synthetic structure was tantamount to PSU banks buying USD from the local market in a period of local USD scarcity – hence in that window RBI might not have allowed this trade to go through and PSU banks themselves would have found it difficult to garner USD in quantum from the local market. Also, considering the backdrop of 300 bps rate hike and widely fluctuating CD spread over MIBOR, the perceived basis risk would have further prevented PSU banks from the synthetic structure.  Coming back to June 2014, as RBI itself was in the buy-mode in USD, they would have more than encouraged the local/PSU banks to raise USD in the synthetic route absorbing USD from the local market.

The current scenario wherein MIFOR-OIS spread almost touched zero also helped this trade to get highlighted.  Even in Oct 2013, MIFOR-OIS spread was not close to zero with OIS being higher than MIFOR by about 50 bps. Psychological viewpoint of not paying any incremental local fixed rate helped this trade gain traction in the current month. 

As this post is written, the MIFOR-OIS spread is close to zero again. It is likely the MIFOR point acts as a floor for OIS and we are likely to see a reversal in OIS from the current 7.80 level towards 8.00.

RBI Handbook on Weekly Statistical Supplement

I have been a fan of the Reserve Bank of India with respect to the Weekly Statistical Supplement which provides reasonably timely and detailed data on the FX and Money markets in India.

Couple of days back, RBI has released a handbook on the WSS data release which, in their own words, "explains various data items and linkage among different tables which will be helpful in enhancing the understanding of the data."

This should be a good reference point for the FX, Debt and Money market dealers in India.

Link: RBI Handbook on WSS

The Japan Trip

It is almost always true that a trip to a foreign land evokes tremendous amount of anxiety and excitement - absolutely true in our case as we went to Japan last month.  Owing to cost effectiveness,our journey from Mumbai to Japan had to start with a domestic hop from Mumbai to Bangalore: thanks to Dragon Air having their Indian hub in Bangalore.

Travelling with a 3 year old has its own charms but travelling with a hyper-active 3-year old meant we encountered adventures throughout the trip starting from the domestic hop.  Our flight from Bangalore to Hong Kong was delayed by about 3 hours - the a priori knowledge of this delay was useless considering the inflexibility of having to take a domestic flight. This meant we had to spend a good 6 hours in the airport from 10 PM in the night till 4:00 AM the next morning - this wait illuminated us about our kid, Sachin: that he becomes even more active than usual if he does not sleep at his usual cut-off times. Most passengers who were waiting for the flight were amazed at his energy level with one of them even jokingly questioning about the food Sachin had for dinner. Before I skip, Sachin was extremely attracted with the skirts worn by the Dragon Air female ground-staffs (probably sign of things to come in future) and this made be extra cautious and vigilant in running behind him to avoid any embarrassments.

The actual flight trip from Bangalore to Hong Kong was mostly peaceful as Sachin immediately slept on boarding the flight even before the take-off and woke up only after landing in Hong Kong airport.With about 3 hours to kill in the airport, we roamed around like vagrants inside the airport looking for some food stuffs for the kid as he had skipped the food provided in-flight. With some difficulty in navigating the large airport, we ended up in a Korean food joint and ordered for Fried Rice and Noodles - the only items in the menu that looked familiar. The food, when it arrived, was anything but familiar. Having spent $260 on the food, we did not have the gall to waste it. After food, despite or because of the lack of sleep, Sachin again became super-mischievous and started running after the Golf-cart like carts just like dogs chasing cars, testing the free computer terminals and scaring other kids on the way. His heightened level of activity again resulted in a peaceful flight to Haneda as we mostly slept through the flight.

Following are the locations we visited in Japan - mostly in sequence - Hakone, Odaiba - Miraikan, Aquarium, Fuji Safari, Kamakura, Disney Sea, Tokyo-Shibuya, Akihabara.

Hakone:

The main attractions before we started were the Step Train (Hakone Tozan Railways), Cable Car, Ropeway, Sulphur eggs of Owakudani and Ferry ride at Lake Ashinoko. The Step train was the most interesting aspect as it was the first "Japanese" thing we did: it is a train that alternates the direction of the journey along a vertical zig-zag track system to climb the mountains.  The old fashioned, but effective, signaling systems was definitely a thing to remember. The next mode of transport was a cable car which took us further higher in altitude and enabled us to take rest and lunch we had brought from home. The third leg of the journey was the most expected one - the ropeway ride from Gora to the place of Black eggs - Owakudani - (not sure about the names though) - the mild drizzle outside meant we view the scenery, hot springs via our eyes and not the camera lenses. The trip should have lasted 25 minutes but it was quite a memory with super tall trees, Mount Fuji amidst the clouds and smokes from Hot Springs. On reaching Owakudani, the drizzle meant the younger and the older ones from our entourage rested at a restaurant while the curious, brave ones ventured into a mild trekking of about 200 metres to the place where the Black eggs were getting prepared from natural Sulphur (or some compound of it) from the hot springs. Apparently, eating one of the Sulphur eggs is supposed to increase life span by 7 years. The next target for us was Lake Ashinoko - for which we took the ropeway again to Togendai.  The ferry/boat ride was as usual, the overcast conditions meant some of the long distant attractions were lost. From Togendai, we returned base to Yokohama - Totsuka in the evening in a bus. This was probably the first time I travelled in so many modes of transport in a single day: Normal Train, Step Train, Cable car, Ropeway, Ferry and Bus.

Odaiba:

After a day's rest, we headed towards Odaiba which is an island (manmade) built in the 19th century but has grown into a busy sea-port. The first attraction of the day was the monorail ride - which is a couple of bogies going at 45-50 kmph without a driver. The clear skies meant the 25-30 minute ride gave us a wonderful viewing pleasure of the rainbow bridge, roadways and skyline of the city.  After the halt for refreshments and photo clicks at the Statue of Liberty replica, we went to Miraikan - a museum for emerging scientific developments. We spent a good 4-5 hours there - notable memories were the Harinacs, Asimov robot and quite a lot of too technical stuffs. At 1300 yens entry fee, it was not a day well spent both in terms of money and time. In the evening we went to a shopping mall which turned out to be interesting with a Hawaiian event going on - in which my wife and kid even danced.

Fuji Safari Park:

The next attraction we visited was the Fuji Safari park - unlike the previous visits, we arranged for a van and went along with my brother-in-law's colleagues. The journey to the park from Totsuka itself was picturesque as the clear skies let us have a bountiful view of Mount Fuji.  The decision was cost effective as the intra-safari ride itself would have costed 1300 Yens per head.  We saw various wild animals - bears, tigers, lions, rhinos, elephants and some more - but the major difference that hit me there was the sheer number of animals they housed for each category: I would have seen close to 20 lions within a 50 square metre radius and the same can be repeated with the other wild animals.  After the safari drive got over, we got glimpses of the usual other caged animals that any zoo will have. Kangaroos were new though.

Kamakura:
The key attraction for this location was the trams which would go through the streets: but it turned out to be a disappointment owing to the vacation crowds - got a feeling of travelling in a Mumbai local.  First we visited the Hasedera temple - it was more of a greenery and sight seeing spot than a temple.  It was quite a pleasant scenery and got multiple photo opportunities.  Next we headed towards the Great Buddha - a large bronze statue of Buddha - probably the worst experience of the day.  Firstly, it was crowded; secondly, the key attraction - of going inside the statue - turned out to be a pain with the 3 year old kid as the stairs were extremely narrow and steep. And nothing great was within the statue other than two boards that explained the specialty of the statue - which can be found on the Internet itself. From there, amidst a painful drizzle, we went to the Aquarium. Apart from the usual attractions, the large underwater pool and Penguin shows were memorable.  There was a dolphin show as well which made the steep entry fee of the Aquarium somewhat worth it.

Disney Sea:
The last tourist spot we visited whilst our stay was Disney Sea: there was a decent bit of planning on the day prior to the visit so that we can optimize the time and visit most of the key attractions there.  After understanding the mechanics of how "Fast Pass" works, it was mostly a game on scheduling especially when going with people aging from 3 to 60. Though the entry fee of 6400Y appeared expensive, when compared to some of the earlier places we visited (Aquarium, Miraikon), Disney Sea was quite a value-for-money deal at 6400Y. Among the various rides and shows, the top 3 would be "Journey to the Center of the Earth", "Toy Story Mania" and "Indiana Jones".  The light show at night was quite a sight as well.

Some of the day to day memories are from Daisa - the 100Y store which housed the "Made in China. Made for Japan" products and a lot of interesting products at cheap prices though at lower-than-Japan quality.  People-wise, I feel in any commercial relationship Japanese are more courteous than Indians while in other situations they just might their own business so much so they are indifferent. 

All-in-all it was a worthy two weeks spent in Japan.

10Y Yield shooting higher

The 10Y bond seems to have broken its short term trading range of 8.65-8.80 and is currently trading at 8.85. There have been some calls for a 9.20+ levels there.

Technically, as long as we do not close below 8.83, the upside in yields is pretty much open. Come April and a front loaded borrowing calendar (INR 80000 Cr of redemptions in the first 45 days), 10Y yield is looking to stabilize at much higher levels than at present.

Inverted Yield Curve & Investors Aversion to Long Term Securities

G-Sec markets have become extremely sideways in the last one month - starting with the release of Urjit Patel Committee's report. The following chart highlights the same:

Learn About Tableau

Since the beginning of February (despite the Fab start to February), the 10Y bond has been mostly trading in the 8.70-8.80 zone with declining volumes despite the flurry of good news (in CPI & WPI) and slightly incredible news (like the Vote on Account).

At this point, it is interesting to note the below chart on FII debt utilization status:

Learn About Tableau

Three points to ponder:

• FIIs have fully utilized their T-bill quota. This broadly means they cannot bring in money to invest in T-bills when the Tbill issuance is higher than in January and perceived tightness in March. This supply-demand mismatch in short end of the yield curve is likely to keep the short term yields high - close to the MSF rate.
• For domestic investors, with no rate cut in sight, there is immense sense to invest in short end of the yield curve especially when it is inverted. The DIIs should continue to shift away from duration securities to short end of the curve.
• The above two points only suggests that the long term yields are sticky and I find them to be floored at 8.65-8.70 as we gradually move towards the next fiscal calendar.

At this point, as I suggested in my earlier post, the trading range for 10Y bond seems to be 8.65-8.80 for some more time.

Fab Start to Feb for India G-Sec

Continuing from my last post See-saw January for India GSec, the short term target of 8.70% has been already met thanks to INR stability, better than expected spectrum auctions and easing off in global yields.  Though the underlying story of supply-demand is still in place for the current quarter, I do not see large invetor interest coming in to longer term G-Secs. Difficult to see investors taking on duration risk when 10Y yield is at 8.70%(though annualized rate would be 8.89) while 1Y yield is at 8.97% .

This is not to say 10Y yield cannot go below 1Y yield or any shorter term yield, but just that it is possible only when we are in the cusp of a rate cut cycle beginning. With most in the market not calling for a rate cut in the immediate future, an inverted yield curve leaves nothing for investors to continue in the longer duration papers.  To be fair, mutual funds have been consistent sellers in the last fortnight with that section of the market alone selling close to INR 9000 Cr since 20th January. How much of that selling is owing to redemption pressures and how much is owing to fund managers' view on the market remains to be checked with data.

Short term range I see for 10Y G-Sec is 8.65%-8.80%. Range play recommended.

See-saw January for India GSec

India bonds had a see-saw of a January with yields moving from 8.80% to 8.47% and back to 8.87%. Variety of factors contributed to this wild swing:

• Return of FII into the Debt market segment
• The first half of the month saw inflow from FIIs - mostly into the T-Bill segment so much so that they utilized about 90% of their allotted USD 5.5 Billion quota.  We have not seen such high utilization of any segment of the debt market since May 2013.  With T-Bill segment close to the brim, it was only natural for the market to believe any incremental money would have to go to the longer tenor segments.
• Surprises in CPI and WPI prints 
• Both CPI and WPI for the month of December surprised the market on the downside; CPI print came sub 10% at 9.87% - sharply lower than the  11.24% of November. Similarly, WPI saw a downtick of close to 135 bps at 6.16% against prior print of 7.50% and market expectations of close to 7%.
• Cancellation of an Auction
• Along with the renewed FII interest in the new year and the positive momentum set by lower inflation prints, RBI/Government cancelled the G-Sec auction of third week of January triggering a break of 8.70%.
• OMO announcement and Incremental Repo
• As if the bullish momentum set by the FII interest, Lower inflation prints and Auction Cancellation are not enough, RBI announced a surprise OMO which confounded many in the market given that its announcement came just a day before another liquidity infusion announcement via 28 day term repo. This segment of the month can be called the 'exuberant' moments of the month with sections of the market calling for a 8% target for the 10Y benchmark citing the supply-demand dynamics for the quarter. 10Y benchmark touched 8.47% intraday.
• Debt Switch
• The bullish momentum and the exuberance were halted by the announcement of debt switch programme by market 'sources'.  Most market participants did not expect the Government to do debt switch (wherein they buy short term bonds and sell longer term bonds) when the 10-14Y segment of the yield curve is above 9%. With all the bullishness of the month so far, suddenly the debt switch became a credible story which the market believed and began to add caution to their bullish trades.
• Urjit Patel Committee Report
• Next was the release of the much awaited, much dreaded report on changes in the way monetary policy is conducted in India including: CPI targeting, formation of monetary policy committee, Term repo as preferred liquidity tool etc.  This report set the cat among the pigeons as to what could be RBI's intent going ahead. Bond yields saw a retracement of close to 50% of the month's move (back to 8.65-67 levels) as an after-effect of this single report.
• Fragile Five
• EM currencies came under attack with Argentinian Peso, Turkish Lira, South African Rand all seeing a mini-run in the Forex market; this accelerated the FII debt outflow from Indian markets as well. 
• RBI hiking rates
• To top it off the madness of the month, RBI gave the final stroke by hiking rates contrary to market expectations. This completed the bond yields' swing for the month taking it back to where it all started.

Looking ahead: With debt supply coming to an end after next week's auction - the supply demand dynamics should again start getting focus as passive Investors like Insurance companies (LIC has recorded a 32% increase in premium collections this financial year - see Link), Provident Funds will have to buy G-Secs as prudentially stipulated.  The biggest risk to this view would be if the Government announces additional auction.  With a sharp pull back and investor interest close to 8.85% in 10Y as seen on Friday, I would put my bets on long side at 8.80% for a move towards 8.70%. 

The SDL Valuation game

Today's State Development Loans (SDL) saw better than market expected cut-offs in the auction (Auction results page): with yields in the range of 9.35%-9.40%. If an investor (read: banks / Mutual Funds) has bought the SDLs in auction today, they would get a valuation gain of close 27-30 bps owing to weird valuation mechanisms followed in India.

As per FIMMDA valuation guidelines, SDLs are valued at 25 bps spread over corresponding G-Sec. Though INR 8000 Cr of SDLs are sold in auction today - the auction cut-off prices are not used for valuation but spread over GoI 8.83% 2023 security is used. As an illustration, if an MF/bank has bought 10Y Tamilnadu paper at 9.41% yield, it can instantly show a gain of 9.41% MINUS (8.83%+0.25%) of 33 bps or equivalently close to 2.31% overvaluation.

With the current quarter being pathetically bad for most fixed income investors (read: banks) they might tend to use such 'valuation' gains to hide real losses in their bond portfolio. In times when most global regulators are seeking more transparency, it is a sham(e) India still continues to have such not-so-above-the-table valuation practices.

Expectations from Revised Monetary Policy Framework

RBI Governor, Raghuram Rajan, during his much celebrated September 4 market interaction informed about the formation of a committee under Deputy Governor, Urjit Patel, for proposing changes to the existing monetary policy framework.  This revised framework was expected to be released in 3 months time.

Since 3 months have since elapsed, market speculation about the likely release of the new framework has kept the Indian rates market under check with extremely reduced duration risk appetite and trading volumes.

The key outcome of this revised framework could be

• The new 'inflation' anchor to the monetary policy rates. Currently, RBI uses the WPI as the main policy anchor with a 'comfort' level (not a target) of 5%; must admit RBI also looks at Core WPI and CPI amongst other inflation measures.  
• Preferred liquidity management tool: OMO or Term Repos?

Inflation Anchor
In the new framework, RBI might shift the inflation anchor - following are the options:
WPI to CPI
This is a shift which will make Indian inflation numbers comparable with the rest of the world; simple for not-so-sophisticated portfolio investors to look at 'real' yields across countries. The main drawback of the CPI measure is its volatility - with food having close to 48% weightage in the index, the headline CPI is subject to swings based on seasonality or frictional factors impacting food.  Setting policy rates on a volatile index is definitely undesirable.

WPI to Core CPI
On more than one occasion, Raghuram Rajan has cited the trends / levels of Core CPI as one of the reference point for the monetary policy decision.  With core CPI actually reflecting household inflationary expectations, I expect this to be the likely choice of inflation anchor for RBI.  There are some calls by research houses that RBI might choose Core CPI minus Housing as housing has not shown interest rate sensitivity in the last 5 years: but, in my opinion, over a longer observation period, real estate and housing are definitely sensitive to interest rates and the complete Core CPI should become the monetary policy's preferred inflation anchor.

Liquidity Management: This would be of particular relevance to bond traders and mutual fund managers. Till the introduction of term repos, RBI typically uses purchases in Open market operations (OMO) to infuse liquidity into the banking system. OMOs had been used even for frictional liquidity stresses like advance tax outflow windows. But with term repos, the requirement for OMOs have somewhat been reduced. RBI had been looking at OMOs only if liquidity stresses were seen to be longer than just being frictional - say stress for 2-3 months. If term repos are extended beyond 14 day tenure to 30 day / 60 day tenures, the need for OMOs would be drastically reduced. OMOs would then be used only in times of primary liquidity withdrawal like USD sales or lack of growth in M0 is hampering credit offtake.

Indian yield watchers are keenly tracking this. Shift to Core CPI as inflation anchor and employment of longer tenure repos are likely to be bond negative.  Are we taking the new 10Y benchmark to 9+ yield levels?

CPI linked IINSS - not attractive at all

CPI linked securities were touted by RBI and Finance ministry to be the main answer to counter the ‘menace’ of gold buying by Indian citizens. Here is how the new product offered by RBI stacks up against the yellow metal.

Investible Limit

IINSS: Minimum lot size is INR 5000 and maximum is INR 5 lacs per annum. The upper cap on the investment baffles me.

Gold or Gold ETF: Minimum lot size is 1 unit of the ETF which typically is 1 gram equivalent. Maximum is generally not capped unless some AMC suddenly acts to be patriotic and limit future investment in the ETF.

Result: Gold is better than IINSS as there are no restrictions on the minimum or maximum lot sizes.

Lock-in and Liquidity

IINSS: 3 years for general public and that too after a penalty of 50% of last coupon – additionally can be done only on the coupon date.  Even the WPI linked bonds are much saner in this aspect as they allow selling any time post the purchase.

Gold: No Lock-in whatsoever.

Result: Gold is better than IINSS as there is practically no lock-in and liquidity is proven.

Tax Treatment

This is the most crucial aspect which totally baffles me as to what the IINSS product designers were thinking.

IINSS: The coupon is fully taxed at the investor’s marginal tax rate. As per the specification of this product, the interest is accrued semiannually but paid out at the maturity after 10 years.  But the investor has to show the interest each year and provide for tax. The retail investor can’t arrive at the coupon received on checking his bank statements and pay tax, but has to ‘compute’ the interest earned using an Index which the RBI itself has declared to be not yet stable. The investor has to compute interest on a complex index, calculate tax (no TDS) based on his marginal income tax rate and pay income tax on an interest payment he has not received - not going to receive in the next 10 years.  The net negative cash flows owing tax payments can easily outdo the 1.5% yield premium provided. Outrageously bad.

Gold: The investor can ‘generate’ a coupon by selling the units of ETF. Short term capital gains tax are the investor’s marginal tax rate – effectively same as IINSS. Long term capital gains tax (>1 year) is after application of indexation benefits: 10% without indexation and 20% with indexation. The best part is the indexation itself is based on CPI.

Result: IINSS is particularly worse in this regard with the issuer (who is also the tax collector) having the cake and eating it too. IINSS is probably the only financial product in the country which has a lock-in period without any tax benefit either at investment or at income stage.

Overall Verdict: If you are patriotic and want to donate money for the nation’s welfare, IINSS would be more profitable than giving money directly to PM fund. The main declared objective of IINSS was to shift investments from gold to IINSS – I expect that wont happen one bit.

On a serious note, IINSS is definitely inferior to Gold ETF on a variety of factors as listed above – only solace for IINSS is it can’t have negative return while Gold can have negative returns – that is true for any fixed income investment vs risk asset investment; even tax free bonds issued by PSU companies offer more value than IINSS; WPI linked bonds offer better value than even tax free bonds because of the low coupon and better effective tax treatment; easiest of all – even debt mutual funds offer more value than IINSS because of the tax angle.The only product that IINSS can possibly beat is bank fixed deposits - even FDs have some tax benefits when booked for 5 year tenure.

Bottomline: I will stick to WPI linked bonds than to invest in IINSS if I want to be anchored to a local inflation index.


Suggestions to RBI/Government of India: 
A flat income tax rate of 10% on the coupon + option of taking out coupons semiannually could make the product sufficiently attractive. 

World's Top Strategy Charts to look out in 2014

Interesting read covering a wide areas of politics, economics, markets and any thing that can impact financial markets

The Most Important Charts of the Year - from Wall Street's Brightest Minds (Business Insider)

Is Indian Debt Market closer to Global Bond Index Inclusion?

All markets have been fearing the impact of likely US Taper, likely announcement to happen over this week with cut backs to start as early as January.  Interestingly, Indian bond markets have seen sharp inflows in the last one week, despite the slew of good economic data in US. Tbills and dated securities have been bought by FIIs to the extent of INR 2000 Cr each, intense buying post the CPI data. 

Most of the dated securities buying has been by the Longer term investors (like Sovereign wealth funds, Pension funds, Insurance funds etc.). Buying of Tbill at the current USDINR forward levels suggest the FIIs' comfort on USDINR spot as well - as they can't be hedging when the forward levels are so high (8.25%+LIBOR).

Are we closer to bond index inclusion than what the local markets believe?

Source of Data: NSDL

Must Read article for India Fiscal watchers

This article is a must-read for fiscal watchers. Seeing through the fiscal math with reasonable 'comparable' numbers - India is heading towards a fiscal cliff.  I have not done the checking of the figures here, assume Business Standard would have already done it.

Link from Business Standard

New 10Y bond heading to 9% handle

The Economics affairs secretary just made a press statement that Indian Government will conduct the much feared "Debt-Switch" programme in the market and not with RBI as was previously expected by the market considering the high yield levels.

This practically means INR 50000 Cr of debt supply to the market at a time when there is little interest in the secondary market; even PFs are opting for the yield pick-up from Corporate bonds and State Development loans post the recent change in investment pattern norms.

Even if Government buys back G-Secs maturing in 2015, 2016 and 2017 and issues, say, 15Y papers, the net duration in the market is going to raise sharply. All set for 9% mark even in the new 10Y bond in few trading sessions from now.


Reuters link

IFC Rupee Bond success

IFC issued INR 1000 Cr of bonds to global investors which has been lapped up happily by foreign investors. For starters, it is a 3 year bond which got issued at coupon of 7.75%. The money collected by IFC will be invested into Indian companies and the investors take the currency risk. It leads to the question what are the foreign investors trying to tell us with the cut-off for the bond issue.

This leads to a direct question of why the coupon has been fixed at 7.75% not close to 9.25% where current 3Y corporate issues (AAA) should be trading at - as the currency risk is with the investors. 

As per my understanding, the intermediation of IFC is taking care of two main risks for which the investors are sacrificing close to 150 bps of yield pick-up despite taking on currency risk on INR:
1. Credit Risk: Even if the Indian corporates to whom IFC lends money defaults, the investors will still get back the money in INR terms. It is to be noted that IFC is AAA rated in $ terms.
2. Convertibility risk: Investors are assured of dollars at the end of 3 years; they are exposed to capital gain / loss depending on INR spot levels but they need the assurance of getting the dollars at the end of three years. Without IFC mediation, they could end up not being able to convert the INR into dollars - sounds like a risk India might totally stop outflows if things go further wrong from here.

Just for the record,US Treasuries for 3Y are at 0.60%; 5y BBB- (India rating) spread is close to 300 bps. Hence, India's dollar yield should be close to 3.60% for 3 years. For corporates, there would be a further spread of 60-70 bps taking the Corporate yield in dollar terms to 4.30%.  With INR yield of corporates trading at 9.30%, the IFC issue of 7.75% suggests foreign investors are pricing in the credit risk of AAA Indian corporates and Convertibility of INR to USD at 155 bps. 

Business Standard Link

10Y yield above 9% - Investors to come in next?

There have been quite a few calls on TV in the last couple of days about shifting of assets from Equities to Debt. It is not counter intuitive given the fact 10Y GoI Security had found itself only few times above 9% in the last 10 years. Though past data could be insufficient to explain future price action, it need not be completely ignored.

Following is the histogram of 10Y yield on closing basis:

  

With Current 10Y yield at 9.05% (1.4% event in last 10Y), it is only natural to see longer term investors coming into the market. Hopefully.