Debt Market: How 2020 hit us and Outlook for 2021 | Explained

For the debt market the most valuable lesson has been the way the crisis was handled by RBI and the Government. Both have done a commendable job. RBI reacted swiftly towards the end March when the redemption crisis threatened to unhinge the credit markets and ensured rates cooled off. Government has offered various schemes to ease credit flow from banks with guarantees and liquidity facilities.

Record banking system liquidity, benign money market rates and support through open market operations have been the main hallmarks are the key pointers: Reuters

Coming towards the end of an extraordinary year, a year which hit us with COVID 19 pandemic in an unprecedented manner there is much to reflect on and learn from, says Bekxy Kuriakose, Head – Fixed Income, Principal Asset Management. Here is an explainer:

For the debt market the most valuable lesson has been the way the crisis was handled by RBI and the Government. Both have done a commendable job. RBI reacted swiftly towards the end March when the redemption crisis threatened to unhinge the credit markets and ensured rates cooled off. Government has offered various schemes to ease credit flow from banks with guarantees and liquidity facilities.

In fact since then financial conditions have achieved remarkable stability. Record banking system liquidity, benign money market rates and support through open market operations have been the main hallmarks are the key pointers. This remarkable support has been felt not just in the debt market but also the equity market. Most debt funds like gilt funds, dynamic funds and even high quality short term category funds have done well with many delivering double digit one year annualized returns. So while the year was terrible health wise, at least there is some consolation wealth wise.

So what does 2021 hold? And how should Investors position their portfolios? We think from the debt market perspective some trends are worth watching

• The current RBI governor and MPC have a pro-growth tilt which should last well into 2021.
• This would mean ample banking system liquidity, continued OMOs (Open market Operations) to cool off gilt and SDL(State Development Loans) yields and keep cost of funding low for banks to facilitate credit flow
• The Budget will be a key event but while the government is aiming for fiscal consolidation, it may be difficult to target a substantially lower fiscal deficit in FY 2022.
• Relaxations to attract FPI inflows into debt may gather further steam.
• There has been a meaningful shock to demand and “animal spirits” of the consumer and the entrepreneur will take time to come back.
• While banking system liquidity remains comfortable we expect it to progressively go down as economic activity normalizes further. This may lead to some uptick in money market rates and spreads of high quality CDs/CPs may widen as compared to T bills which are currently in the range of 0-35 bps.

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As the effects of MTM gains wane off, debt fund returns may normalize in 2021 and this may cause investors to look at “greener pastures''. However we would still advise investors to exercise caution and avoid high risk credit investments, ensure their portfolios are well diversified and prioritize safety of principal over returns.

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