Funds Buy Most Bonds in 11 Months on Rate Outlook: India Credit

Funds Buy Most Bonds in 11 Months on Rate Outlook
Slowing inflation will spur the Reserve Bank of India to leave the benchmark repurchase rate unchanged at 8.5 percent when it meets two days later. Photographer: Kainaz Amaria/Bloomberg

International investors are adding to holdings of Indian rupee-denominated debt at the fastest pace in 11 months, betting that easing inflation and a slower drop in the rupee will spur a bond-market rally.

Global funds’ ownership has risen $1.6 billion this month, already the most since January, to $23.8 billion, exchange data show. Debt due in 2021 had the best two-week rally since May 2010, with yields dropping 30 basis points in the last nine trading days, according to data compiled by Bloomberg. The 8.53 percent yield on the bonds is more than twice that for China and four times for U.S. Treasuries.

The rupee is still trading stronger than its record low reached last month, after sliding 14 percent this year, on speculation the central bank purchased the currency. Policy makers will start cutting borrowing costs in the fiscal year starting in March as inflation slows to less than 7 percent from the current 9.73 percent, according to Goldman Sachs Group Inc. and Credit Suisse AG.

“The rate cycle is near its peak, inflation is near the top and so bonds will start to perform,” Gordon Rodrigues, a Hong Kong-based investment director at HSBC Global Asset Management that oversees $25 billion in Asian fixed-income assets, said in an interview on Dec. 9. “Intervention is good to smooth out volatility as no foreign investor wants to see large moves.”

Rate to Hold

India’s wholesale-price index probably rose 9.04 percent in November from a year earlier, the least since November 2010, according to the median estimate of 24 economists in a Bloomberg survey before a government report due on Dec. 14. Slowing inflation will spur the Reserve Bank of India to leave the benchmark repurchase rate unchanged at 8.5 percent when it meets two days later, according to ING Investment Management Pvt. and IndusInd Bank Ltd.

The central bank has raised borrowing costs seven times this year, the most of any Asian monetary authority, contributing to a 20.5 percent slump in the nation’s Sensitive Index of shares. Overseas funds cut holdings of Indian shares by $859 million in November, the most since August, while raising their ownership of rupee-denominated notes by $200 million, according to exchange data.

“The strategy to move investments from the equity to the bond market will prove good and profitable,” J. Moses Harding, executive vice president at IndusInd Bank Ltd., said in an e-mail on Dec. 9. “Stock and currency markets will be under pressure till about mid-2013, while the bond market gets into bullish mode.”

Currency Reserves

The rupee weakened 0.2 percent to 52.1475 today, stronger than the record-low of 52.73 per dollar touched on Nov. 22, . Last month’s slump in India’s foreign-exchange reserves was the most since the $39 billion drop in October 2008 that followed the collapse of Lehman Brothers Holdings Inc. Reserve Bank Governor Duvvuri Subbarao declined tell reporters in Calcutta on Dec. 8 if policy makers had intervened in markets to stem the currency’s drop.

India’s 10-year government bonds advanced for a fifth straight week in the five days to Dec. 9. Yields on the 8.79 percent notes due in November 2021 fell 1 basis point to 8.53 percent today after dropping 11 basis points, or 0.11 percentage point, last week, according to the central bank’s trading system. Similar-maturity securities fetched 3.50 percent in China and 2.1 percent in the U.S., according to data compiled by Bloomberg.

Auction Demand

The Finance Ministry sold 130 billion rupees ($2.5 billion) of six-, nine-, 13- and 30-year debt at an auction on Dec. 9 as part of the government’s record 4.7 trillion-rupee borrowing plan in the year ending March. It received bids of 1.7 rupees for every rupee of the notes it sold at the auction. The central bank has bought 243 billion rupees of bonds from the market since Nov. 24 to support the government’s issuance plan, pushing the 10-year bond yield to a two-month low.

India’s debt has returned 1.4 percent so far this month, the third-best performance among 10 Asian local-currency bond markets monitored by HSBC Holdings Plc.

“Supplies are still high in the market with the government’s borrowing plan,” said Debendra Kumar Dash, a fixed-income trader at Development Credit Bank in Mumbai. “The government’s buyback of bonds is supporting the 10-year right now, and if this stops then yields could rise again.”

The cost of protecting the debt of State Bank of India against non-payment using credit-default swaps has almost doubled this year. Five-year contracts on the lender, viewed as a proxy for the nation, cost 361 basis points on Dec. 9, compared with 161 basis points at the end of 2010. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

Declining Volatility

The implied volatility on one-month dollar-rupee options has fallen to 11.7 percent from this year’s high of 14 percent reached on Nov. 22, according to data compiled by Bloomberg. The measure of expected swings in exchange rates is used to price options.

Investors who buy top-rated one-year Indian company bonds by borrowing dollars at the London Interbank Offered Rate of 1.08 percent gain a yield of 3.1 percent after taking into account the cost of hedging against a drop in the rupee, according to HSBC Asset’s Rodrigues.

Three-month offshore rupee forwards traded at 53.21 to the dollar today, compared with 52.25 on Dec. 9. Forwards are agreements to buy or sell assets at a set price and date. Non-deliverable contracts are settled in dollars.

Outweigh Risk

India’s higher yields outweigh the risk of currency depreciation, according to ING Investment Management, a unit of the largest Dutch financial services company. The difference in yields between India’s 10-year bonds and similar-maturity U.S. Treasuries was 647 basis points today compared with a record-high 697 reached on Nov. 9, according to data compiled by Bloomberg.

“The yields are attractive and are more than what investors would get in most markets,” K. Ramanathan, the Mumbai-based chief investment officer at ING Investment Management that oversees $270 million, said on Dec. 9. “That’s what is boosting investment in Indian debt.”

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