The following article is based on my own interpretation of the said events. Any material borrowed from published and unpublished sources has been appropriately referenced. I will bear the sole responsibility for anything that is found to have been copied or misappropriated or misrepresented in the following post.
Abhishek Barui, MBA 2015-17, Vinod Gupta School of Management, IIT Kharagpur
90% of the downgrades which came in the first half of FY16 is owed to the firms from either investment-linked or commodity sectors. As the Indian economy shows initial signs of recovery and the business environment becomes more conducive, the stalled projects, which amounts to Rs 10.7 trillion6, will start picking up. As a result, the debt on the books decreases as these projects become profitable which in turn would result in rating upgrades for these firms.
Additionally, the expected implementation of GST in 2016 will improve the prospects of the capital goods and engineering sector. GST would bring in a predictable tax regime by combining the central and state tax and by providing a tax credit at every step of production. GST could improve the cost competitiveness of the companies in this sector.
On the other hand, the metal players are expected to have a torrid time for a considerable amount of time due to Global and especially Chinese economy slowdown. China, being the largest importer of commodities for the past few years and largest metal importer of India, is facing a slowdown. The Chinese economy is expected to grow by 7% in the next fiscal. This has also led to dumping of steel from Japanese and Chinese steel makers, piling more misery on the Indian metal sector. There has also been low demand from the Euro zone for the metals.
Additionally, with the Indian economy expected to grow at a rate greater than 7%, there is a chance of rating upgrade from the rating agencies making India more attractive to the foreign investors. This would help in reducing the yields of the Government bonds in turn reducing the yields of corporate bonds resulting in price appreciation.
RBI cutting the repo rates from 8% to 6.75% last calendar year did not had a profound impact on the growth of the economy with the nominal GDP growth still estimated at 8.6%. With the inflation under control and WPI negative, there is still a case for future rate cuts this year.
But the rate cuts have failed to affect the yield of the Government bonds majorly due to low liquidity. The 10-year G-sec bonds’ yields has only decreased from 7.728% on Feb 01, 2015 to 7.723% on Feb 01, 2016. The supply of these G-secs are very high compared to liquidity available in the system. These high yields are a deterrent to the corporate bonds as their prices depend on the yield of the Government bonds. Additionally, the liquidity in the corporate bonds are even lower.
Inflation in India has been under control majorly due to softening oil prices. The Consumer Price Index inflation has stayed in the range of 3.69% to 5.61%. RBI’s monetary policy is designed keeping inflationary target of 5% in mind, as a result inflation is not expected to get out of control.
This would mean inflation not having a serious effect on the corporate bond yields, rather providing the companies a chance for secular growth.