Demonetization and its Impact on Fixed Income Investments

The historic demonetization move by the government is a war on parallel economy, corruption, money laundering and to stop financing aid enjoyed by the terrorists. We expect this to have a far-reaching impact on Indian economy. It might have short-term pain but sure long-term gains.

Apart from flushing liquidity in the banking system, demonetization could create short-term disruption in consumption and lead to behavioural changes in households saving and consumption demand.

We expect the following macro-economic scenario to play out going forward.

Improvement in Governments fiscal position

System Liquidity to increase

Inflation expected to fall further

Growth to be positively impacted over medium to long term with near term hiccups

We have been positive on Indian bonds for a while now with the view that monetary easing cycle will continue and better liquidity in the banking system will push bond yields lower. With the Governments latest announcement of de-monetizing higher denomination notes, our view further got strengthened. We expect further easing in terms of 50-75 bps of rate cuts in the near future.

Macroeconomic factors such as lower inflation and better fiscal will aid bond markets. On the other side, it is likely that the RBI will have to defer open market operation purchases to infuse liquidity into the banking system. That said, we believe rate cuts, better liquidity, better medium-term fiscal and disinflationary impulse should outweigh the lack of OMO purchases.

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