Relief Package – battle of Bonds & Equities!

Bond Vs Equities: Classic battle!

As I pen this quick note, PM Narendra Modi has just finished his 33 min speech promising Indians an unprecedented relief package amounting to 10% of GDP !

Yes, it tantamount to a fascinating number of 20 Lakh Crores.

And its important to note that SGX Nifty is trading 5% up currently on this news and is likely to make a big bang splash at the opening bell tomorrow morning.

Final contours of this package are not yet out and as always – devil will lie in the details. Few important points:

• This will encapsulate all other packages announced so far by Govt and RBI both.
• Which means existing announcement made by RBI of about 3.74L crore are subsumed in this number
• And all other announcements made by FM so far, also are a subset of this number
• Our sense is this will also encompass all other government schemes, benefits and grants which are announced otherwise in normal course of the year.

Inspite of all the above points, the sheer enormity of this number is likely to create uproar on bourses in days to come. There was also a token symbolism indicating that perhaps lockdown4.0 will mean controlled relaxation in business activities. Its quite likely that businesses will be allowed to resume and economic activity put back on track following adequate safety protocols. PM’s speech also indicated relaxation and reforms in sticky land and labour laws. And few states have already started acting on this front. This could potentially unleash the economy towards a new decade of growth.

All this creates a heady concoction for equity markets – and days ahead could be rewarding for Equity investors. Though we still feel that upside seems limited for the time being to a 10K mark on Nifty unless economic conditions change dramatically (refer our previous mail titled: “Where are the Equities headed”).

On the flip side: it creates massive question marks on the fiscal condition of the Union of India. Its important to note that our stated Fiscal deficit number for the year was 3.5% and we currently enjoy a rating of BBB- by international rating agencies, which is already the lowest rung of Investment grade rating.

Package amounting to 10% of GDP and existing deficit prognosis will lead us to a fiscal deficit of 13-15% for the full year (Disclaimer: these are just approx. guess numbers). Needless to say, rating downgrade will loom large like a sword of Damocles over our head. A rating downgrade could have a spiralling domino effect be it prospects for borrowing in International markets, massive exodus of foreign funds from the country, pushing the currency towards 80 against USD or even possible difficulty for corporates borrowing in international markets.

Summary:

It’s a classic battle of Kurukshetra between Bonds & Equities – from which the fog should be gradually lifted over the next few days as we try to decipher where are the two assets headed.

Bond markets can see a sharp spike in yields and resultant losses in all Debt funds with portfolio durations above a year.

This should get compensated by an equally strong rally in Equities on the other hand. For equity markets – it should be festivity and investors who are holding on and have invested more – can finally reap some rewards of their patience.

Even the most purist of economists will find it tough to pick sides between fiscal prudence and economic package currently.

Between this classic battle of Bonds & Equity – hopefully, the country will gain! And as they say, Hope is a good thing!

Our advice:

Stay away from all debt funds which have greater than 1 year modified duration (or average maturity). Yields are likely to shoot up resulting in negative returns.

It might be little too late to make a sudden dash in equities tomorrow. Wait for the euphoria to settle down before jumping on the bandwagon.