Bonds Beat BRIC Rivals as Inflation Shows Signs of Slowing: India Credit

Indian bonds outperformed those of the largest emerging nations in the past month, with the biggest decline in yields relative to Treasuries among BRIC nations, on signs inflation is slowing.

A government report today showed the wholesale-price index rose 8.58 percent in October, the least since January, according to a government statement. Yields on India’s 10-year bonds dropped relative to U.S. treasuries more than Brazil’s, while similar rates in Russia and China jumped.

Central bank Governor Duvvuri Subbarao’s decision to raise interest rates six times this year is boosting confidence he will tame benchmark inflation that is about twice the rate in Brazil and China and more than 2 percentage points above Russia’s. Nomura Holdings Inc. forecast India’s benchmark yield will drop 28 basis points to 7.80 percent by March after data last week showed slowing factory output and food-price gains.

“We expect the RBI to pause in its rate hikes in the immediate future given the softening trend in inflation and factory output,” said Sonal Varma, a Mumbai-based economist at Nomura. “It is prudent for the RBI to take stock of previous policy actions.”

The yield on the benchmark 10-year notes was little changed at 8.07 percent. The rate is 524 basis points, or 5.24 percentage points, more than similar-maturity U.S. Treasuries, down from 558 a month earlier, according to data compiled by Bloomberg. The gap for Brazil’s 10-year yields narrowed one basis point, while the spread widened three points in Russia and 16 in China during the same period. Brazil, Russia, India and China make up the so-called BRIC markets of the largest emerging nations.

Industrial Output

Growth in industrial production slowed to 4.4 percent in September from this year’s high of 16.8 percent in January, the government said on Nov. 12. The previous day, Commerce Ministry data showed food inflation slowed to a one-year low of 12.3 percent in the week to Oct. 30.

“Given the deceleration in factory output, we think the RBI is likely to hold rates,” Jay Shankar, a Mumbai-based chief economist at Religare Capital Markets Ltd., said in an interview on Nov. 12. “We were earlier expecting a 25-basis point increase by March. The chances of that have diminished after the deceleration in the key economic data.”

He forecasts the benchmark yield will drop to 7.90 percent by January. The Reserve Bank predicted on Nov. 2 that benchmark wholesale-price inflation may slow to 5.5 percent by the end of March.

Bond Volatility

India uses the wholesale-price index as a benchmark for measuring inflation. The consumer-price inflation rate for industrial workers quickened 9.82 percent in September. In contrast, consumer price inflation rate rose 5.2 percent in Brazil, 7.5 percent in Russia and 4.4 percent in China.

The government raised $2.5 billion, selling seven-, 10- and 30-year bonds at maximum yields of 7.99 percent, 8.10 percent and 8.49 percent at an auction on Nov. 12.

India’s government bonds underperformed earlier this year as average inflation in the first nine months jumped sevenfold to 9.7 percent. The securities returned 3.9 percent this year, the third-worst performance among 10 Asian local-currency debt markets outside Japan, according to indexes compiled by HSBC Holdings Plc.

Narrowing swings in the bond yields of Asia’s third-biggest economy signaled a smaller potential for losses. A measure of the 10-year rate’s 30-day historical volatility has declined to 7.5 percent from 19.1 percent in May, data compiled by Bloomberg show. A similar gauge was at 17 percent in Brazil, 12 percent in Russia and 19.3 percent in China.

Treasury Yields

The cost of fixing rates on money for a year in India’s interest-rate swap market has declined eight basis points from a two-year high of 6.83 percent reached on Oct. 28, data compiled by Bloomberg show.

The rupee appreciated 3 percent this year as the Reserve Bank raised the benchmark repurchase rate 150 basis points to 6.25 percent, attracting fund inflows into the nation. The currency dropped 0.7 percent today to 45.12 per dollar today.

Yields in the U.S., the world’s biggest economy, have also climbed on speculation efforts by the Federal Reserve to spur the economy will lead to faster inflation. The benchmark 10-year treasury yield rose to 2.79 percent on Nov. 12 from 2.65 percent a day earlier.

Bank Holdings

The Reserve Bank said on Nov. 2 that increases in global commodity-prices pose a risk to its inflation outlook. Record share sales in India have also starved the bond market of funds, raising overnight borrowing rates to an average 6.3 percent this quarter from 5.4 percent in the previous three months.

Banks, the biggest buyers of government debt, raised their holdings by 1.8 percent in the two weeks to Oct. 22, the most since April, before a cash shortage in the last week of the month prompted them to cut their positions, Reserve Bank of India data show.

Factory-output and India’s food inflation data “don’t really matter for investors as long as the liquidity shortage continues,” Prasanna Ananthasubramaniam, the Mumbai-based chief economist at ICICI Securities Primary Dealership Ltd., said in an interview on Nov. 12. “Liquidity is a bigger concern now.”

Cash Crunch

The Reserve Bank has increased daily lending to banks to alleviate the cash squeeze. The central bank lent 1.2 trillion rupees ($27 billion) to local lenders Nov. 11, an all-time high.

The cost of protecting the debt of government-owned State Bank of India, which some investors perceive as a proxy for the nation, has decreased 70 basis points to 169 from a one-year high reached in May, according to CMA prices.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

“The industrial-output data indicate further hikes may not be necessary,” Roy Paul, deputy general manager at Mumbai-based Federal Bank Ltd., said in an interview on Nov. 12. “It’s a good level to enter bonds in the backdrop of a likely pause.” He predicts the 10-year yield will drop to 7.60 percent by March.

To contact the reporter on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net; 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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