Bank Treasurers Cut Bond Holdings at Fastest Pace Since 2005: India Credit

India’s banks are cutting bond holdings at the fastest pace in five years, deterred by accelerating inflation and the widest swings in debt prices in six months.

Lenders sold 288.3 billion rupees ($6.4 billion) of debt last quarter, the most since the three months ended Dec. 31 2005, central bank statistics show. The 30-day historical volatility of benchmark notes rose to 10.2 percent on Jan. 10, the highest level since July, data compiled by Bloomberg show.

The government’s 10-year bonds now yield 8.14 percent, the most among Asia’s 10-biggest economies after Indonesia, ahead of a report today that will probably show inflation quickened for the first time in three months in December. The Reserve Bank of India will review its assessment that price gains will slow to 5.5 percent by March when policy makers meet to review rates on Jan. 25, Deputy Governor Shyamala Gopinath said last week.

“Bond yields are bound to rise further,” Anubhuti Sahay, a Mumbai-based economist at Standard Chartered Plc, said in an interview on Jan. 12. “With inflation expected to be well above the central bank’s comfort level, we expect further interest- rate increases by March.”

The British bank, the first foreign company to sell shares in India, predicts the yield on benchmark bonds may climb to 8.50 percent by March. Indian banks disclose the details of their Treasury operations when releasing earnings.

Wholesale Prices

The yield on the 7.8 percent bonds due May 2020 has climbed 23 basis points since the end of last year in the run-up to the Reserve Bank’s policy meeting. The rate touched 8.26 percent, this year’s high, as banks’ bond holdings have dropped by 584 billion rupees from a high of 14.97 trillion rupees in the two weeks ended Oct. 22. The yield on the notes dropped three basis points to 8.14 percent yesterday on signs the availability of cash at banks improved.

Benchmark wholesale prices rose 8.4 percent last month from a year earlier, after having increased 7.48 percent in November, according to the median forecast of 30 economists in a Bloomberg survey before data due today. Food prices rose 16.91 percent in the week ended Jan. 1, near the previous week’s 18.32 percent that was the fastest pace of increase since July, commerce ministry data showed yesterday. Food accounts for about 14 percent of India’s inflation.

The surge in prices may force the central bank to raise the repurchase rate by 50 basis points when it meets for the first time this year, according to Robert Prior-Wandesforde, the Singapore-based head of India and South Asia economics at Credit Suisse Group AG. The Reserve Bank boosted the rate, at which it lends to banks, by 150 basis points to 6.25 percent last year.

‘Bear Trap’

Policy makers at the central bank need to weigh more than just inflation at this month’s meeting, according to IndusInd Bank Ltd., whose shares have gained the most in the Bombay Stock Exchange’s index of banking stocks in the past year. Government data on Jan. 12 showed industrial production rose 2.7 percent from a year earlier in November, the slowest pace in 18 months.

“The bond market is in a bear trap as inflationary pressures mount,” J. Moses Harding, a Mumbai-based executive vice president at the bank, said in an interview yesterday. “There’s pressure on the RBI to hike rates, but it can’t afford to take an aggressive monetary stance as concerns about a slowdown in economic growth are increasing.”

The central bank may buy back government bonds from lenders to pump money into the financial system even if it decides to raise rates to cap inflation, he said. Such repurchases will ease the impact of higher borrowing costs on economic growth, according to the bank.

Cash Availability

Lenders borrowed 703 billion rupees ($15.6 billion) on average a day from the central bank this month, according to data compiled by Bloomberg. They tapped 1.2 trillion rupees a day in December as the sale of third-generation mobile-phone licenses in May and Internet permits a month later drained more than $1 trillion from the financial system.

“I continue to be bearish on bonds because we will see a rate hike this month,” Killol Pandya, who manages the equivalent of $111 million in debt funds at Shinsei Asset Management Pvt. in Mumbai, said in an interview yesterday. “Also, liquidity in the banking system is still above the central bank’s comfort zone.”

He predicts the rate on the May 2020 bonds could climb as high as 8.30 percent by the end of March.

Debt Returns

The difference in yields between the security and U.S. Treasuries due in a decade has widened to 479 basis points from a six-month low of 442 on Dec. 28. India’s three-year government bond yield of 7.78 percent compares with 12.6 percent in Brazil, 3.29 percent in China and 7.02 percent in Russia.

India’s bonds lost 0.4 percent this month, Asia’s third worst performance after Indonesia and South Korea, according to indexes compiled by London-based HSBC Holdings Plc. Rupiah notes declined 2.65 percent while Korean bonds slumped 0.6 percent. The rupee has weakened 1.2 percent so far this year, Asia’s third-worst performance, data compiled by Bloomberg show. The currency slid 0.2 percent yesterday to 45.2450 per dollar.

The cost of protecting the debt of government-owned State Bank, which some investors perceive as a proxy for the nation, has climbed 18 basis points this month to 178 basis points, 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.

The central bank needs to consider the borrowing plan for the financial year starting April, according to Gaurav Kapur, senior economist at Royal Bank of Scotland NV, which is a primary dealer for India’s debt. The government plans to borrow 4.47 trillion rupees this fiscal year, after raising a record 4.51 trillion rupees in the previous 12 months.

“The government’s borrowing program next year won’t be significantly lower than this year,” Mumbai-based Kapur said in an interview on Jan. 12. “The debt supply is a big problem.” He forecasts the policy rate will go up by at least 75 basis points in 2011.

To contact the reporters on this story: V. Ramakrishnan in Mumbai at rvenkatarama@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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