Inflation Approaching 8% Seen Eroding Real Yield: India Credit

India’s inflation-adjusted bond yields, already the lowest among the largest emerging markets, deteriorated further after this year’s worst price report.

The so-called real yield on India’s 10-year sovereign note has slid 103 basis points from this year’s high in August to 36 basis points, according to data compiled by Bloomberg. Similar gauges were at 425 basis points in Brazil, 158 in China and 137 in Russia. India’s benchmark price index jumped 7.81 percent last month from a year earlier, the most in 2012, a government report showed today. The median estimate of economists in a Bloomberg News survey was for a 7.7 percent increase.

“Inflation is a bugbear and none of us is expecting it to come down soon,” Killol Pandya, the Mumbai-based head of fixed- income investments at the local unit of Daiwa Asset Management Co., said in an interview on Oct. 11. “Our track record with inflation has been poor. In the short term, bond returns will be eroded and people already invested will take a bit of a knock.”

India’s banks, the biggest buyers of sovereign debt, cut holdings last month by the most this year as the central bank refrained from reducing the highest interest rates among major Asian economies, citing price pressures. The Reserve Bank of India’s policy focus is on tempering inflation, which remains above its comfort level, Governor Duvvuri Subbarao said Oct. 4. Borrowing costs need to come down to revive growth, Finance Minister Palaniappan Chidambaram said in an interview on Oct. 12, saying his reform push may create room for rate reductions.

The pace of price increases in India, where the World Bank says about two-thirds of the people live on less than $2 a day, has averaged 7.5 percent so far in 2012, the most among the so- called BRIC economies. Average inflation in 2012 was 5.3 percent in Brazil, 2.8 percent in China and 4.6 percent in Russia.

‘Unusually Uncertain’

In July, the RBI raised its forecast for gains in the wholesale-price index in the year ending March 31 to 7 percent from 6.5 percent. The monetary authority has held its repurchase rate at 8 percent since April, when the benchmark was cut by 50 percent in the only reduction since 2009. Subbarao boosted the repo rate by a record 375 basis points through 2010 and 2011.

Emerging-market central banks from Brazil to China and South Korea reduced borrowing costs in the second half of this year to shield their economies from the impact of Europe’s debt crisis. It’s too early for India to follow suit because of its inflation, the International Monetary Fund said in its World Economic Outlook report released on Oct. 9.

“The outlook for India is unusually uncertain,” the Washington-based lender said. “Monetary policy should stay on hold until a sustained decrease in inflation materializes.”

Swaps, Bonds

Interest-rate swaps, derivative contracts used to guard against fluctuations in funding costs, signal investors pared bets for rate reductions since June. The cost of locking in one- year borrowing costs has risen 13 basis points from a 14-month low of 7.48 percent on June 12, data compiled by Bloomberg show.

The yield on benchmark 10-year government bonds has climbed 13 basis points from a 14-month low of 8.04 percent in June, data compiled by Bloomberg show. The extra amount investors seek to hold the notes instead of U.S. Treasuries has widened 20 basis points, or 0.2 percentage point, from a six-month low of 631 touched last month.

Bank deposits in India are growing at near the slowest pace in at least five years as inflation erodes returns. Savings rose 13.8 percent in September, according to the latest central bank data. The pace of increases touched 13.1 in April, the least since at least 2007.

‘Savings Rate Collapsing’

“Keeping money in a bank or in a bond is running against inflation,” Harihar Krishnamoorthy, Mumbai-based treasurer at the Indian unit of FirstRand Ltd., South Africa’s second-biggest financial services provider, said in an interview on Oct. 11. “That’s probably the reason the savings rate is collapsing.”

Rupee-denominated sovereign debt returned 8.5 percent so far in 2012, trailing the 20 percent earned by Brazilian notes and the 9.2 percent gain on Russian securities, according tindexes compiled by JPMorgan Chase & Co. The rupee declined 0.6 percent to 53.1325 a dollar today.

The rupee advanced 4.7 percent in the second half of this year, Asia’s best exchange-rate performance, according to data compiled by Bloomberg. Crude oil in New York has retreated more than 9 percent from a four-month high of $100.42 per barrel on Sept. 14. India imports almost 80 percent of the oil it uses.

The government’s policy changes in the past month will boost the rupee further and help slow inflation to between 5 percent and 5.5 percent by March, India’s Economic Affairs Secretary Arvind Mayaram spoke in an interview with Bloomberg Television in Tokyo yesterday.

‘Greater Comfort’

Prime Minister Manmohan Singh has reduced energy subsidies, cut taxes on overseas borrowing by companies and allowed more foreign investment in industries including retailing and airlines since mid-September.

“There’s greater comfort on the inflation front now because of stable commodity prices and gains in the rupee that have been beyond expectation,” J. Moses Harding, executive vice president at IndusInd Bank Ltd. in Mumbai said in a telephone interview on Oct. 12.

Bond risk for government-controlled State Bank of India, a proxy for the sovereign, remained higher this year as inflation pressures persisted. The cost of insuring the lender’s debt for five years against non-payment using credit-default swaps has averaged 331 basis points so far in 2012, compared with 209 a year earlier, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in privately negotiated markets.

Diesel Prices

The government’s move last month to raise state-controlled prices of diesel for the first time in more than a year will further fuel inflation, according to Crisil Ltd., the local unit of Standard & Poor’s. Prime Minister Manmohan Singh’s government boosted diesel tariffs by about 14 percent to reduce expenditure on fuel subsidies that have fanned a budget deficit.

“The increase in diesel prices will push up inflation in the short run,” Dharmakirti Joshi, Mumbai-based chief economist at Crisil, said in an interview on Oct. 12. “I expect the October reading for the wholesale-price index to be 8 percent.”

To contact the reporter on this story: Tushar Dhara in New Delhi at tdhara1@bloomberg.net.

To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net

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