India: Tempered Optimism

India: Tempered Optimism
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India: Tempered Optimism

Hopes were high last year that India’s new Prime Minister Narendra Modi could revitalize the economy, but expectations were far too optimistic, and a more mixed, pragmatic outlook has since taken hold. This tends to be the pattern in India: Because of its huge potential – with 1.2 billion people and 60% of the population below 30 years of age – investors can become mesmerized by the scale and tend to read too much into cyclical turns.

Nevertheless, even as the post-election euphoria has subsided, there are reasons for optimism on India’s investment potential. While the credit sector is no longer an exceptional value, we see opportunities in duration in local markets and would look to add currency exposure during periods when markets become risk-averse.

Under new management: Untangling the web of bureaucracy and aligning regional and central governments are daunting tasks, but Prime Minister Modi, leader of the Bharatiya Janata Party (BJP), is known for his anti-corruption and pro-business stance. Already, talk is circulating of a second term, which, while far too early to predict, would allow time for real change.

At the Reserve Bank of India (RBI): Raghuram Rajan, the new governor of the RBI and former IMF chief economist, is leading a regime change, steering the central bank through a new monetary policy framework that includes inflation targeting.

Inflation targeting: The RBI and the Ministry of Finance agreed to an inflation target below 6% by January 2016 and 4% thereafter (within a 2% band). For the historically high-inflation economy, this is a pivotal change, and if global inflationary pressures remain subdued, the target can be achieved.

Evolving bond/rates markets: Access to India’s local markets for foreign investors may increase by up to $10 billion over the next few months, although liquidity will likely remain low. The central bank cut interest rates by 25 basis points on June 2 and further rate cuts are expected before year-end. In addition, the government is working on new guidelines for global bonds, which should increase issuance, and tax reform appears to be a real possibility, a big plus for local markets.

Within India there is much debate: Is India the next China? Certainly the government’s projection for GDP growth this year at 7% or higher is eye-catching. But with a smaller economy, the need for huge structural reform, and less capability to make swift political decisions on the economy, India is not another China. India is its own unique story, and the world’s largest democracy, as the locals say, maneuvers slowly.

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Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio.