A rally in India’s corporate bonds that pushed their yield premium over sovereign debt to a five-month low is losing steam, according to SBI Funds Management Pvt., prompting it to favor government debt.
The extra yield on AAA securities issued by companies over sovereign notes has dropped 69 basis points from a three-year high on July 26 to 83 basis points, according to data compiled by Bloomberg. Comparable spreads were at 147 basis points in China and 28 in South Korea. Bond sales by local companies surged to a record in 2012 as funding costs for top-rated issuers slumped to the lowest level since January 2011.
“Government bonds offer much better value as corporate notes have rallied quite a bit in the past two months,” Rajeev Radhakrishnan, who helps manage the equivalent of $9.8 billion in local assets at the unit of the nation’s largest bank, said in an Oct. 15 interview. “We have been increasing our exposure to government bonds as the curve offers a lot of opportunity given the positive monetary policy outlook and fiscal consolidation efforts.”
A burst of policy changes by Prime Minister Manmohan Singh in the past month to curb the budget deficit and counter a slowing economy have increased prospects of interest rate cuts in coming months, making sovereign notes attractive, according to Reliance Capital Asset Management Ltd. and Quantum Asset Management Co. Radhakrishnan predicts the central bank will buy as much as 820 billion rupees ($15.5 billion) of bonds in the next six months as the government sells a record amount of debt.
Reserve Bank of India Governor Duvvuri Subbarao has kept the benchmark repurchase rate unchanged at the last three policy meetings to curb the fastest inflation among the biggest emerging economies, and focused on measures to boost lending. The rate at which the monetary authority lends to banks was last cut in April, when it was lowered to 8 percent from 8.5 percent.
The central bank has reduced the proportion of deposits lenders must set aside as reserves this year to an eight-year low 4.5 percent from 6 percent at the end of 2011, and more than tripled export-credit refinancing to help revive growth. The RBI next reviews policy on Oct. 30.
Gross domestic product will increase 4.9 percent in 2012, the least in a decade, the International Monetary Fund said Oct. 9, as it called for interest rates to be kept unchanged until price increases cool. Quarterly growth slowed to an average of 5.4 percent in the first half of 2012, from 8.6 percent in the first six months of 2011, according to the most recent government data.
The yield on the five-year bonds of state-owned companies has dropped 70 basis points from this year’s peak of 9.66 percent on July 26, according to data compiled by Bloomberg. The rate on similar-maturity government notes climbed 8 basis points to 8.12 percent in the same period, the data show.
Citigroup Inc. and SBI Funds predict the RBI will cut the repurchase rate by at least 50 basis points by March, while BNP Paribas SA expects a 25 basis point cut. A half percentage-point reduction will push 10-year bond yields lower by 40 basis points to 7.75 percent, said Radhakrishnan of SBI Funds, a unit of government-controlled State Bank of India.
The yield on the 10-year benchmark notes dropped 41 basis points to 8.15 percent in 2012 as growth slumped. The debt offers an extra 634 basis points over similar-maturity U.S. Treasuries, versus a 169 basis-point premium on Chinese bonds.
Inflation in India has averaged 7.5 percent so far in 2012, compared with 5.3 percent in Brazil, 2.8 percent in China and 4.6 percent in Russia.
Singh and Finance Minister Palaniappan Chidambaram began pushing pro-growth policies in mid-September, ending two years of policy gridlock. They have slashed energy subsidies, reduced taxes on overseas borrowing by companies and allowed foreign investors 51 percent ownership of retail outlets and to hold minority stakes in local airlines.
The measures came after Standard & Poor’s and Fitch Ratings lowered their outlook for India’s investment-grade ratings.
S&P reduced India’s 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 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.
“There is little possibility of fiscal profligacy given the threat of a ratings downgrade,” Radhakrishnan said.
India’s budget deficit is the widest among major emerging economies as slower growth hurts tax receipts and subsidies fan spending, imperiling the government’s goal of narrowing the gap to 5.1 percent of GDP in the fiscal year through March 2013, from 5.8 percent the previous 12 months.
The shortfall may be about 5.2 percent to 5.3 percent this fiscal year, Economic Affairs Secretary Arvind Mayaram said in an Oct. 14 interview.
India’s rupee has surged 4.5 percent since Sept. 13, when the policy revamp commenced with an increase in diesel prices. The currency weakened 0.3 percent to 53.0550 per dollar today, according to data compiled by Bloomberg.
Bond risk has declined. Credit-default swaps on State Bank, which some investors consider a proxy for the sovereign, fell 145 basis points in 2012 to 250 in New York, according to data provider CMA. 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.
The finance ministry said Sept. 27 it will stick to its plan to borrow 5.69 trillion rupees this fiscal year. Rupee-denominated debt returned 8.1 percent this year, the second-best performance among the 10 Asian markets monitored by HSBC Holdings Plc. Indonesian bonds returned 8.3 percent.
The RBI may buy between 750 billion rupees and 1 trillion rupees of government bonds by March 31, said Amitabh Mohanty, who oversees $16.8 billion of assets as the head of fixed income at Reliance Capital Asset Management Ltd. in Mumbai. He predicts the central bank will cut its benchmark rate and lenders’ reserve requirement 25 basis points each on Oct. 30, sending 10-year yields toward 8 percent by early November.
“We believe enough conditions have been created by the government for the RBI to cut rates this month,” Mumbai-based Mohanty said in an Oct. 15 interview. “The government has been proactive in trying to ensure the fiscal deficit slippage isn’t huge, and there is more value in 10-year sovereign bonds.”