Rupee Bond Yields Are Poised to Rise Above Inflation

Yields on India’s 10-year government bonds are poised to rise above the inflation rate for the first time since January as the central bank tames prices.

Inflation-adjusted yields ended last week at negative 0.57 percent, compared with minus 3.1 percent at the end of May, as the benchmark wholesale price index moderated to 8.62 percent from 10.6 percent. The Reserve Bank of India estimates the pace of price increases will slow to 6 percent by the end of the current fiscal year in March.

International investors are pouring money into India’s government bond markets, betting that the five interest-rate increases this year by Reserve Bank of India Governor Duvvuri Subbarao, the most in Asia, will succeed in curbing inflation. Overseas investors pumped $10.3 billion into rupee debt in 2010, more than the $7.12 billion they put into Malaysia notes.

“The RBI has raised rates more aggressively than the market expected at a time when many Asian central banks put policy on hold,” said Rajeev De Mello, the Singapore-based head of Asian debt at Western Asset Management Co., which oversees $470 billion. “That gives more credibility to its efforts to cool inflation, and we are more positive on rupee assets now than before.”

Relative Yields

The last time India had positive real yields was in January. The improvement is the most of any Asian nation, according to data compiled by Bloomberg, adding to the appeal of the region’s fastest-appreciating currency. Inflation-adjusted yields have dropped 347 basis points in Indonesia, 132 in the Philippines and 82 in Malaysia, Bloomberg data show.

India’s rupee surged to a two-year high this month as export growth accelerated after the government lifted a limit on debt inflows 50 percent to $30 billion. Western Asset, the Pasadena, California-based fixed-income unit of Legg Mason Inc., bought rupee non-deliverable forwards and the South Asian nation’s government bonds in the past month.

Real yields in Indonesia declined to 1.31 percent from 4.78 percent on May 31, and those in Malaysia dropped to 1.62 percent from 2.44 percent.

Investors are buying Indian bonds after the debt underperformed earlier this year as the Reserve Bank raised its reverse repurchase rate, at which it absorbs cash from lenders, by 1.75 percentage points to 5 percent. The securities returned 3.8 percent in 2010, the second-worst performance after China among 10 local-currency debt markets in Asia outside Japan, according to indexes compiled by HSBC Holdings Plc.

‘Normalizing Policy’

The yield on India’s 7.8 percent note due May 2020 rose 27 basis points, or 0.27 percentage point, this month to 8.12 percent. It has jumped 53 basis points this year.

India’s government raised 110 billion rupees ($2.5 billion) selling bonds at an auction on Oct. 15. It sold five-year notes at a maximum yield of 7.80 percent, 10-year debt at as much as 8.07 percent and 17-year securities at 8.40 percent.

“The RBI is the region’s only policy maker that stuck to its guns in normalizing policy,” said Kenneth Akintewe, a Singapore-based investment manager at Aberdeen Asset Management Plc. The firm oversees $261 billion. “India is the only bond market that has substantially priced in inflation and policy risks. Real yields will improve further as inflation eases.”

India’s 10-year bond yield is the highest among the major emerging economies except Brazil, where similar-maturity notes pay 11.7 percent. Comparable securities offer 7.34 percent in Russia and 3.31 percent in China and 2.53 percent in the U.S., according to data compiled by Bloomberg.

Central Bank

The difference in yields between India’s debt due in a decade and similar-maturity U.S. Treasuries widened 20 basis points this month to 5.53 percentage points. The gap has expanded from 3.75 points at the end of 2009 and touched a record 5.6 points on Oct. 11.

Inflation still remains “well above” the central bank’s “comfort zone,” Deputy Governor Subir Gokarn said Oct. 5 in Mumbai, prompting speculation of more monetary tightening. Subbarao, who will review policy rates on Nov. 2, will boost the benchmark rate by at least 50 basis points by March, ING Investment Management Pvt., an Indian venture of the biggest Dutch financial-services company, predicts.

“We may see a rate hike next month and thereafter an extended pause unless inflation continues to remain rigid,” said Shubhada Rao, a Mumbai-based chief economist at Yes Bank Ltd., which is partly owned by Rabobank Nederland NV and HSBC Holdings Plc. Rao forecasts the central bank will boost borrowing costs by a quarter percentage point at the next meeting.

Rupee Gains

Global funds boosted ownership of India’s corporate and government debt to an all-time high of $18 billion on Oct. 8, exchange data show, after returns from the notes climbed to 0.7 percent in September, according to indexes compiled by Bank of America Merrill Lynch.

India’s economic data have been mixed. Growth in industrial production has slowed even as exports increased. Output rose 5.6 percent from a year earlier in August, the smallest increase in 15 months, the statistics office said this week.

The rupee, which gained 0.2 percent in the first six months of the year, has appreciated 0.4 percent since Oct. 1, when the Commerce Ministry reported exports data for August. Overseas sales rose 22.5 percent from a year earlier, compared with a gain of 13.2 percent in July. The currency has advanced 5.1 percent this year to 44.29 per dollar as of 3:14 p.m. in Mumbai.

“The rupee was lagging other currencies earlier this year in spite of India’s strong growth and that made it very attractive from a relative value perspective,” said Aberdeen’s Akintewe. “We have been building sizeable overweight positions in the rupee.”

Aberdeen has been buying the rupee in the non-deliverable forwards market and purchased Indian bonds last month. The asset manager predicts the rupee will advance to 43.5 a dollar in the next six months.

The central bank may intervene if the rupee rises past 43 per dollar, a finance ministry official with direct knowledge of the matter said on Oct. 15. The government is comfortable with the rupee trading between 43 and 45, the official said, asking not to be identified because the issue is sensitive. Policy makers aren’t in favor of curbing capital flows from overseas, and measures to protect exporters will be mainly by intervening in currency markets, the official said.

To contact the reporters on this story: Anil Varma in Mumbai at avarma3@bloomberg.net.

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net

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