Bank Bonds Off to Worst Start Since 2007 as Inflation Rises: India Credit

Indian banks’ dollar bonds are heading for their worst January since before the credit crisis as the fastest inflation in Asia spurs customers to buy gold and property, while deposits fail to keep pace with loans.

The notes returned 0.36 percent this month, their weakest start to a year since they delivered 0.29 percent in January 2007, according to HSBC Holdings Plc’s Indian Dollar Bond Index, which is 71 percent bank debt. HSBC data show a 0.71 percent return for lenders in South Korea, where inflation at 3.5 percent is less than half India’s 8.4 percent.

“The shift of the Indian household sector from deposits to inflation hedges such as property and gold is creating a liquidity crunch in the banking sector that’s unlikely to be solved in the near future,” Kristine Li, senior director of Asia-Pacific credit strategy at Royal Bank of Scotland Group Plc, said in an interview in Singapore. “If banks’ loan growth decelerates, asset quality concerns are likely to return.”

India’s central bank is under pressure to sustain the fastest pace of monetary tightening in Asia after the ballooning cost of food staples pushed inflation to almost double the Reserve Bank of India’s “medium-term” 4.5 percent target ceiling. Bank deposits increased 16.5 percent in the two weeks ended Dec. 31 from a year earlier, lagging a 24.4 percent increase in lending, according to RBI data.

The cash squeeze in Asia’s third-largest economy spurred banks’ loan-to-deposit ratios to a record 75.7 percent in December. Indian lenders borrowed an average 923 billion rupees ($20.3 billion) a day from the central bank in the fourth quarter, the most since 2000.

Wider Spreads

Relative yields on State Bank of India’s $1 billion, 4.5 percent bonds due July 2015, rose 22 basis points this year, while the spread on Axis Bank Ltd’s $350 million, 5.25 percent notes due September 2015, widened 19 basis points, according to data provided by RBS. The spread on ICICI Bank Ltd.’s $750 million of 5.5 percent notes due March 2015 rose 15 basis points, or 0.15 percentage point, RBS prices show.

The cost of insuring Mumbai-based State Bank’s debt with credit-default swaps rose 23.7 basis points to 183.5 this month, putting the contracts on track for their steepest monthly increase since May, prices from data provider CMA show. Swaps on Mumbai-based ICICI climbed 34.4 basis points to 232.6, also heading for their steepest monthly rise in eight months.

The difference in yields between India’s debt due in a decade and similar-maturity U.S. Treasuries was 482 basis points yesterday, widening from 463 at the end of last year.

India, home to 1.2 billion people, is facing a “surge” in inflation because it recovered from the global recession faster than other countries, central bank Governor Duvvuri Subbarao said on Jan. 17.

Onion Prices

The benchmark wholesale-price index rose 8.43 percent in December from a year earlier after a 7.48 percent gain in November, the commerce ministry said on Jan. 14. The cost of onions surged 70 percent in the week to Jan. 1.

“India has had two years of inflationary pressures building in the market and bank bonds are selling off as a result,” Kenneth Akintewe, who helps oversee $261 billion of global assets at Aberdeen Asset Management Asia Ltd., said in a phone interview from Singapore yesterday. “It’s hard to see pricing pressures significantly abating any time soon.”

State-run banks will need to raise more capital to sustain credit growth, Chakravarthy Rangarajan, the prime minister’s chief economic adviser, said in New Delhi on Jan. 7.

The government is targeting economic expansion of 9 percent over the next two decades to cut poverty. While the World Bank estimates there are 828 million people in India living on less than $2 a day, the country’s 100 billionaires have wealth equal to a quarter of gross domestic product and the number of millionaires will triple by 2018, according to Forbes magazine and Merrill Lynch & Co. and Cap Gemini SA estimates.

Gold Demand

As rising salaries boost the wealth of India’s middle- class, demand for gold is rising in the world’s biggest user of bullion. Gold imports probably rose to a record in 2010, driven by investment demand, Ajay Mitra, managing director for India and the Middle East at the World Gold Council, said Jan. 12.

Bullion gained 30 percent last year, reaching a record $1,431.25 an ounce on Dec. 7, as investors bought the metal as a protector of wealth.

Property prices in some parts of India surpassed their pre- crisis peaks in 2007 as urbanization accelerates, Mahesh Nandurkar, a real-estate analyst at CLSA Asia-Pacific Markets in Mumbai, said in November.

“The more wealth creation you get, the greater the demand you’re going to see for other assets,” Aberdeen’s Akintewe said.

Government Notes

The yield on India’s government bonds held at the highest in almost a year yesterday before the central bank reviews policy rates next week. The yield on the 8.08 percent bond due in August 2022 fell 2 basis points, or 0.02 percentage point, to 8.21 percent, according to the central bank’s trading system. Earlier, it touched 8.23 percent, the highest level since Feb. 5.

The rupee fell, approaching its weakest level in seven weeks. The currency retreated 0.2 percent to 45.53 per dollar, according to data compiled by Bloomberg.

India’s inflation means the real interest rate returns on bank deposits are “very low or even negative in some cases,” Nondas Nicolaides, a senior banking analyst with Moody’s Investors Service, said yesterday in a phone interview in Singapore.

“This pushes people to invest their money elsewhere instead of placing it as deposits in banks,” he said. “However our concerns are partly mitigated by the limits Indian banks have in place in terms of overall capital markets exposure as well as real-estate exposure.”

Deposit growth lags loan expansion even after banks raised deposit rates for various maturities by between 100 basis points and 150 basis points since August.

“The valuations of Indian bank’s dollar bonds are rich,” Royal Bank of Scotland’s Li said. “After turning in an excellent performance since early November, we recommend investors take profits.”

To contact the reporter on this story: Katrina Nicholas in Singapore at knicholas2@bloomberg.net

To contact the editor responsible for this story: Will McSheehy at wmcsheehy@bloomberg.net

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