Indian Oil Bonds Hit Record as Diesel Price Increase Seen

Refiner Bonds Rally as Singh Diesel Increase Seen: India Credit
Indian Oil Corp., Bharat Petroleum Corp. and Hindustan Petroleum Corp. sell fuels below cost to help curb inflation in a country where the World Bank estimates about 800 million people live on less than $2 a day. Photographer: Brian Sokol/Bloomberg

Indian Oil Corp.’s most-active dollar bonds are set for a fourth monthly gain, their longest rally on record, as investors bet Prime Minister Manmohan Singh will increase diesel prices for the first time in a year.

The yield on the state-owned refiner’s 5.625 percent debt due August 2021 fell 72 basis points since March 30 to 5.09 percent on July 23, the lowest since it began trading a year ago, data compiled by Bloomberg show. Ten-year notes of Mumbai-based Reliance Industries Ltd., owner of the world’s largest refining complex, dropped 39 basis points this month, more than the 21 basis-point decline in similar-dated bonds of Malaysia’s Petroliam Nasional Bhd.

Montek Singh Ahluwalia, the planning chief, said July 5 the government will “soon” adopt policies to boost confidence, after rating companies warned subsidy cuts are vital to rein in the budget deficit and protect India’s investment-grade ranking. Prime Minister Singh took charge as finance minister June 26, allowing Pranab Mukherjee to win election as president, and pledged an overhaul in response to the slowest economic growth in nine years.

“There’s a warning of a rating downgrade, and if the government doesn’t raise diesel prices to help narrow the fiscal deficit, there will be more trouble,” Hemant Dharnidharka, head of credit research at SJS Markets Ltd. in Bangalore, said in a July 24 interview. “With the presidential elections over, the government can start taking some hard economic decisions.”

Mukherjee, the ruling Congress party’s nominee, was on July 22 elected president of the world’s most-populous democracy with the backing of Singh’s coalition allies, some of whom have opposed increasing fuel prices. Junior oil minister R.P.N. Singh yesterday declined to comment on revising diesel tariffs.

‘Government’s Hands’

“Raising diesel prices is in the government’s hands and we’re hoping something will be done soon,” Indian Oil Chairman R.S. Butola said in a July 23 telephone interview. “There’s a great need to raise prices, for the companies and the economy.”

State-run refiners are free to set gasoline prices, while the government regulates rates for diesel, cooking gas and kerosene that account for more than 50 percent of Indian Oil’s sales volume. Gasoline makes up about 10 percent.

The nation’s biggest refiner raised gasoline prices July 23 for the first time in two months to reduce losses after crude climbed and a weaker rupee made oil imports more expensive. Diesel, kerosene and cooking gas rates were last increased on June 25, 2011.

Brent crude, the benchmark for almost all of India’s imports, rose 6.3 percent this month. The nation imports 80 percent of its oil. The rupee has declined 5.4 percent this year, the second-worst performer in Asia. The currency rose 0.2 percent to 56.076 per dollar at 9:41 a.m. in Mumbai.

Below Cost

Indian Oil, Bharat Petroleum Corp. and Hindustan Petroleum Corp. sell fuels below cost to help curb inflation in a country where the World Bank estimates about 800 million people live on less than $2 a day. The three refiners lose 3.6 billion rupees ($64 million) a day on fuel sales, according to oil ministry data, and rely on subsidies and discounted oil purchases from government-owned explorers to recover losses.

The yield on the refiner’s dollar debt rose 14 basis points this week on speculation pressure from Singh’s coalition allies may delay a decision on prices. While India’s inflation rate unexpectedly slowed to 7.25 percent last month, it was the fastest among the so-called BRIC economies, which include China, Russia and Brazil.

‘Fire Bullet’

“The government has its political compulsions and there’s no escaping from inflation,” Rupa Rege Nitsure, an economist at state-owned Bank of Baroda in Mumbai, said July 24. “There’s no choice but to increase diesel prices as India’s fiscal position is very vulnerable. The government has to fire the bullet.”

Standard & Poor’s lowered India’s sovereign credit outlook to negative from stable April 25, citing slower investment and economic growth. Fitch Ratings cut its outlook June 18 saying progress in paring the budget deficit was limited.

Both companies rank India’s debt BBB-, the lowest investment grade. Asia’s third-biggest economy grew 5.3 percent in the quarter ended March 31, the slowest pace since 2003.

The yield on the benchmark 8.15 percent government debt due June 2022 was little changed at 8.10 percent today, according to the central bank’s trading system. The rupee-denominated notes offer an extra yield of 669 basis points over U.S. Treasuries. Indian bonds returned 6 percent in 2012, the region’s second-best performance, HSBC data show.

Fuel Subsidy

The government’s fuel subsidy bill more than doubled to a record 835 billion rupees in the fiscal year ended March 31. The finance ministry has budgeted 435.8 billion rupees toward fuel subsidies this year, Namo Narain Meena, the junior finance minister, told parliament April 24.

India’s budget shortfall was 5.8 percent of gross domestic product in the last fiscal, wider than the 4.6 percent target. Singh aims to cut the deficit to 5.1 percent this year, in part by reducing total subsidy payouts by 14 percent. Government borrowing is set to surge to a record 5.69 trillion rupees this year, from 5.1 trillion rupees in the 12 months ended March 31.

Diesel prices must be increased “as early as possible” to maintain the deficit target, Chakravarthy Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, said July 20. “Substantive action” on fuel and fertilizer subsidies is needed to narrow the shortfall, central bank Governor Duvvuri Subbarao said in the April 17 monetary policy statement.

India’s bond risk is falling on speculation a diesel price increase will help narrow the deficit.

Sovereign Risk

The cost of protecting the debt of State Bank of India, which companies consider a proxy for the sovereign, dropped 24 basis points this month to 345 basis points, according to data provider CMA. The credit-default swaps pay face value in exchange for the underlying debt should a company fail to adhere to its agreements.

New Delhi-based Indian Oil’s net debt surged 59 percent to 562.6 billion rupees in the year ended March 31, according to data compiled by Bloomberg, and has more than doubled from two years ago as crude costs climbed faster than fuel prices.

“Refiners’ bond yields will drop further with a diesel price increase as it reduces their need to borrow,” said Gopal Agrawal, the chief investment officer at the Indian unit of Mirae Asset Financial Group in Mumbai. “An increase will strengthen government finances, push down government bond yields and bring money in to India.”

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