In aggregate terms, capital flows into emerging markets (EM) have been subdued following a meaningful retracement from November. In fact, flows have come under pressure amid a less-supportive U.S. dollar backdrop; rising U.S. Treasury yields, which has the net effect of compressing interest-rate spreads between EM economies and the United States; setbacks in containing COVID-19; and escalating geopolitical tensions/idiosyncratic risk. This has prompted several central banks in the EM universe (Russia, Turkey, Brazil, and South Africa) to hike policy rates/turn more hawkish in recent weeks. Markets had been quick to extrapolate this trend to other EM central banks, including the RBI. As it turns out, such expectations proved to be misplaced.
RBI: transparent and credible statements
"Whatever it takes"—three words that once signaled former European Central Bank President Mario Draghi’s commitment to maintaining an accommodative monetary policy stance for as long as necessary to secure economic recovery—can be found in RBI Governor Shaktikanta Das’s statement on April 7.¹
In a nutshell, the RBI formalized its quantitative easing program, pledging to buy up to one trillion Indian rupees’ worth of bonds in the current quarter to keep borrowing costs down. This announcement is significant because it’s the first time the central bank has placed a figure on its bond purchasing program. The RBI also extended its on-tap targeted long-term repo operations scheme by six months to ensure there’s enough liquidity to support the economy during the period.¹ In our view, the RBI’s message to the markets couldn’t be clearer.
The macroeconomic context
The yield curve of Indian government bonds has shifted higher in recent months² despite the introduction of multiple liquidity measures and assurances from the RBI that it wasn’t in a hurry to normalize monetary policy. Meanwhile, the central bank’s upbeat outlook in February has already been superseded by the latest developments: High-frequency indicators showed that domestic demand remains anemic as new COVID-19 infections continue to rise across key states while external demand weakened due to the strength of the rupee. Crucially, the recovery in corporate borrowing stalled as the belly of the yield curve (Indian government bonds with medium-term maturities) bore the brunt of the global bond market sell-off.
3- and 5-year Indian government bonds have borne the brunt of the rising yields since January 1
In our view, the RBI had policy room to take a more dovish stand and needed to do so. Even though India’s headline Consumer Price Index inflation rebounded from 4.1% to 5.0% in February on a year-over-year basis,² the recent fall in household inflation expectations suggests underlying price pressures in the country will be contained and inflation should stay below the RBI’s 6.0% upper limit. Besides, India is much less externally vulnerable relative to any point in the past decade—specifically, relative to 2013’s taper tantrum. Crucially, India’s current account moved into a small surplus in Q4 2020, and net direct investment inflow has risen to the highest on record while its reliance on “hot money” is much reduced.
That said, India’s recovery is still fragile, and the RBI’s rate-setting committee will likely be very wary of withdrawing policy support too soon. In its recent state of the economy report, the central bank said, “there is no way the economy can withstand higher interest rates in its current state. It is recovering, but certainly not out of the woods yet.”³ We agree.
India’s economy is relatively less vulnerable to external factors
Focusing on growth
Indian equities have underperformed broader EM since mid-February as net foreign investment inflow has slowed.² Foreign flows into Indian bonds have recovered recently but remain in negative territory.⁴ A firm commitment by the RBI to maintain an accommodative monetary policy stance for an extended period on the back of a historically expansionary Union Budget should leave no doubt that monetary policy is working with fiscal policy to secure India’s future growth potential and help to revive foreign investor appetite for Indian assets.
In our view, India’s future growth potential can be attributed to the following factors:
- India continues to be one of the fastest-growing economies in the world. (The International Monetary Fund projects a growth rate of 11.5% in 2021.)⁵
- By 2030, India is projected to be one of the world’s largest economies (measured by market exchange rates).⁶
- The government’s Make in India policy is focused on self-reliance and building up domestic industry to lift the share of manufacturing in GDP from 17.0% currently to 25.0% over the medium term⁷; India is emerging as an alternate manufacturing investment destination.
- Labor costs in India remain competitive.
- Demographic advantage—approximately half of its population is aged under 25, and India will continue to have one of the youngest populations in the world until 2030.⁸
- Average household incomes are forecast to triple over the next two decades and it’s one of the fastest-growing affluent populations; India is forecast to be the world's fifth-largest consumer economy by the year 2025.⁶
- India is relatively insulated from geopolitical tension that could disrupt supply chains given its relatively lower exposure to external demand (exports represent ~10.0% of GDP⁴) and has much higher domestic demand-driven growth.
- There's a possible global bond index inclusion in the future, which would attract greater capital inflows.
In our view, the RBI is right to decide against going down the path of policy normalization as several of its EM peers have done. While uncertainty remains, by strengthening its commitment to accommodative monetary policy through transparency and clear communication, the central bank has laid the foundation for what could be a strong economic recovery in India.
1 “Governor’s Statement,” Reserve Bank of India, April 7, 2021. 2 Bloomberg, as of April 6, 2021. 3 “RBI BULLETIN: State of the Economy,” Reserve Bank of India, March 19, 2021. 4 Reserve Bank of India, Macrobond, as of April 6, 2021. 5 “World Economic Outlook Update,” imf.org, January 26, 2021. 6 “World Economic League Table 2021,” Centre for Business Economics and Research, December 2020. 7 makeindia.com, March 2021. 8 UNFPA India, March 2021.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other preexisting political, social, and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management or its affiliates. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
Manulife Investment Management
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional.
Australia: Hancock Natural Resource Group Australasia Pty Limited., Manulife Investment Management (Hong Kong) Limited. Brazil: Hancock Asset Management Brasil Ltda. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad 200801033087 (834424-U) Philippines: Manulife Asset Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC and Hancock Natural Resource Group, Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.
Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by its affiliates under license.