Bond-Quota Sales Fail as Pimco Frets on Inflation: India Credit

Indian Prime Minister Manmohan Singh
Manmohan Singh, India's prime minister. Photographer: Pankaj Nangia/Bloomberg

India fell short of its target at a seventh straight sale of permits to buy rupee bonds and existing quotas are underutilized by global funds on concern the fastest inflation among the biggest emerging markets will accelerate.

Overseas investors bought 137 billion rupees ($2.5 billion) worth of licenses on Aug. 20, 55 percent of the amount offered. They owned 161.7 billion rupees of government bonds at the end of July, 29 percent less than the permitted amount, according to the Securities and Exchange Board of India. The margin is the widest since December, and compares with as little as 4.3 percent in February.

India’s budget and current-account deficits are set to overshoot Prime Minister Manmohan Singh’s target amid the weakest economic growth in almost a decade. Central bank Governor Duvvuri Subbarao has refrained from cutting interest rates as the worst monsoon since 2009 threatens to stoke inflation. That’s reduced the appeal of India’s 10-year bond that yields 8.23 percent, almost triple the 3.34 percent in China.

“We are concerned about twin-deficit dynamics and elevated inflation, due partly to the weak rainfall season and oil prices,” Roland Mieth, a Singapore-based senior vice president at the Asian unit of Pacific Investment Management Co., said in an Aug. 22 e-mail. Pimco manages $1.82 trillion, including the world’s biggest bond fund. “The rupee has stabilized but the question remains whether this is sustainable.”

‘Dominant Threat’

Subbarao on July 31 kept borrowing costs at the highest level among the largest emerging markets as he raised the Reserve Bank of India’s inflation forecast to 7 percent from 6.5 percent for the fiscal year to March 31, and scaled back its economic growth estimate to 6.5 percent from 7.3 percent. One of his deputies, Subir Gokarn, said Aug. 19 inflation is the “dominant threat.”

India’s June-September monsoon, which brings more than 70 percent of annual rainfall, was 14 percent below a 50-year average as of Aug. 22, the nation’s weather bureau said.

The 9.3 percent jump in Brent crude-oil futures this month to $114.66 per barrel, following the 7.3 percent gain in July, may spur inflation and widen the current-account deficit, the broadest measure of trade. Asia’s third-largest economy imports about 80 percent of its oil.

The current-account shortfall widened to a record 4.2 percent of gross domestic product in the year ended March 31, from 2.7 percent in the previous fiscal year, RBI data show.

India’s benchmark inflation rate was at 6.87 percent in July, faster than 1.8 percent in China, 5.2 percent in Brazil and 5.6 percent in Russia.

Budget Deficit

Singh’s efforts to keep fuel and food affordable for two-thirds of India’s 1.2 billion people who, according to World Bank estimates, live on less than $2 a day, may prevent the government from meeting its goal of containing the budget deficit at 5.1 percent of GDP in the year to March 2013. The government plans to increase debt sales by 12 percent to a record 5.69 trillion rupees this year to bridge the shortfall.

The gap may touch 5.8 percent, boosting government borrowing by 450 billion rupees, Vivek Rajpal, a Mumbai-based fixed-income strategist at Nomura Holdings Inc. said in a research note yesterday.

“India’s current-account deficit and persistent inflation have resulted in negative sentiment toward the economy,” Alia Yousuf, head of emerging-markets in London at ACPI Investments Ltd., said in an Aug. 22 e-mail. “This, against an uncertain global macro outlook, has damped demand from foreign investors for Indian bonds.” ACPI manages $3 billion of assets.

Bond Yields

The 10-year bond yield has climbed 19 basis points, or 0.19 percentage point, since touching this year’s low of 8.04 percent on June 13. The benchmark note yield was little changed at 8.23 percent today, according to the RBI’s trading system.

Rupee-denominated government bonds returned 8.2 percent in the past 12 months, trailing the 14.5 percent gain in Indonesian securities and 12.3 percent earned by Philippine debt in Asia’s best performances, HSBC Holdings Plc indexes show.

Standard & Poor’s lowered India’s sovereign credit outlook to negative from stable on April 25, saying the move reflects a one-in-three likelihood of a ratings downgrade to junk status because of slower investment and economic growth. Fitch Ratings cut its outlook on June 18, citing limited progress in paring the budget deficit. Both companies rank India’s debt BBB-, the lowest investment grade.

“India appears to be largely in the same position” since June, Art Woo, the Hong Kong-based director of Asia Pacific sovereign ratings at Fitch, said in an Aug. 22 e-mail. “The economy has continued to slow, inflation remains at elevated levels and the budget is still under pressure.”

Default Risk

Bond risk has risen. The cost of insuring the debt of government-controlled State Bank of India, which some investors consider a proxy for the sovereign, climbed 59 basis points in the past 12 months to 320, according to data provider CMA. The average price of credit-default swaps for Asia’s 10 biggest economies dropped about 10 basis points to 130 in the period.

The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to debt agreements. An increase signals worsening perceptions of creditworthiness. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Rupee bonds may yet find buyers after the currency rebounded in the past two months from a record low, according to Aberdeen Asset Management Plc., which manages $300 billion globally.

Rupee Outlook

The rupee has appreciated 3.5 percent to 55.3850 versus the dollar since hitting a record low of 57.3275 on June 22, the best-performance in Asia in the period. The currency has pared its decline in 2012 to 4.02 percent. It will end the year at 54.85 per dollar, according the median forecast in a Bloomberg survey.

“With the rupee stabilizing, you can see a more constructive landscape for risk,” Kenneth Akintewe, a Singapore-based fund manager at Aberdeen, said by telephone on Aug. 22. “Relative yields are definitely attractive.”

The failure to sell all the bond quotas offered at auctions may stem from a rule change in January, when SEBI said permits bought by foreigners will lapse upon redemption or sales. That curbed investors’ ability to take advantage of market opportunities, according to ACPI.

Rule Change

“The turnover restriction has prevented inflows seeking arbitrage opportunities between Indian and foreign rates through the bond and foreign-exchange markets,” ACPI’s Yousuf said. “Until overall foreign sentiment towards Indian investments improves, we expect to see some under-utilization in the quota limits.”

At New York-based Invesco Advisers Inc., Senior Portfolio Manager Claudia Calich is staying out of the Indian market partly due to concerns about the economy and capital controls.

“The nation’s outlook remains challenged by its twin fiscal and current-account deficits, slow implementation of structural reforms and high inflation,” Calich, who oversees $1.7 billion of emerging-market assets, said in an Aug. 22 e-mail. “Even at current valuations, we see better investment opportunities elsewhere in Asia.”

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