India assets awaiting election outcome; Indo govvies look undervalued

Philip Wee23 May 2019
    Photo credit: AFP Photo

    India rates: Attention squarely on the election outcome

    Domestic financial markets rallied on Monday, buoyed by favourable exit polls, which predicted a second term for the ruling coalition (see here). Return of the incumbent government is a business-as-usual scenario and good for policy/ reform continuity. Benchmark 10Y yields eased toward 7.3%, while expectations for rate cuts and liquidity support perked short-term bonds.

    Final election results will trickle in today, where investors will seek clarity on the incumbent government’s performance. The 10Y yield is likely to ease to the weaker end of the 7.25-7.35% range, if results mirror the exit poll. On the contrary, weak support for the ruling regime will be construed as a negative risk event, sending yields towards 7.4%. Ability of markets to sustain gains, thereafter, hinges on the direction of global catalysts, particularly oil prices and US-China trade dispute, as these weigh on regional flows and markets.

    Political considerations aside, subdued sentiments in the domestic credit markets is likely to take precedence for the central bank. A rating downgrade and resultant surge in bond yields of a non-bank mortgage lender fuelled worries over the creditworthiness of weaker players in the sector. Respite is not in the offing as the RBI dismissed the need for a dedicated credit line to struggling entities, where problems are seen as solvency driven, rather than due to a shortage of liquidity. Separately, NBFCs with more than INR50bn in assets had been asked to appoint a Chief Risk Officer to tighten risk management plans. Concurrently, a new operational framework is in the works for non-banks to improve on their asset-liability mix. Focus is also on the RBI’s revised circular to replace the February 2018 version, which had placed stringent course-correction steps for banks to deal with stressed assets.  

    Rates: Indo govvies look undervalued       
    Indonesia govvies appear to be bearing the brunt of collateral damage from the escalation in China-US trade tensions. Since the start of April, 10Y yields have risen by close to 50bps to 8.10% as USD strength becomes ascendant. It is probably no coincidence that foreign ownership started to ease over the same period. Demand for Indo govvies is still lacklustre with the recent round of auctions drawing just IDR 26tn worth of bids (of which ISD 10.8tn is accepted). With the 3M USD/IDR NDF forward points still elevated (likely on the back of post-election uncertainties), foreign investors are likely to stay on the side lines for now.
    That said, our Asia Rates Valuation Indicator (ARVI) suggests that Indo govvies are the most undervalued (by a significant margin) compared to peers. The last time Indonesia displayed this level of relative undervaluation was during the height of the emerging market selloff in 3Q18. Notably, real rates are high and Bank Indonesia has thus far been on the cautious side (refraining from joining India, Philippines and Malaysia in easing monetary policy) as the USD/IDR drifts higher. In the current challenging external backdrop, rate cuts are probably not in the offing just yet.

    Radhika Rao

    Economist – India, Thailand & Eurozone

    Eugene Leow

    Rates Strategist - G3 & Asia

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