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Goldman Sees RBI Inflation Focus as Curve Inverted: India Credit

Goldman Sees RBI Inaction as Yield Curve Inverted
Men rest in the waiting area of the MorBhawan bus station in the Sitabuldi area of Nagpur, India. Goldman Sachs pulled forecasts for further reductions in Indian rates in the fiscal year through March 2014 after the rupee fell past 60 per dollar for the first time on June 26. Photographer: Dhiraj Singh/Bloomberg

India’s bond market is the most pessimistic on the economy since the global credit crisis as a plunge in the rupee prompts the central bank to shift its policy focus back to fighting inflation.

The yield on two-year sovereign notes rose 41 basis points since May 31 to 7.73 percent, 17 basis points more than 10-year debt, as the currency slid 5.7 percent in Asia’s worst loss. The yield curve is near the most inverted since 2008, a sign investors expect more economic weakness. In China, securities due in a decade offer 33 basis points more than two-year ones.

Deutsche Bank AG last week joined Goldman Sachs Group Inc. in scrapping forecasts that the Reserve Bank of India will cut rates this month for a fourth time in 2013. The Reserve Bank of India yesterday boosted two of its lending rates by two percentage points each, while holding the benchmark repurchase rate at 7.25 percent, and said it will sell government bonds this week to drain cash from the financial system.

“The bond market is dealing with uncertain times,” A.S. Thiyaga Rajan, a senior managing director at Aquarius Investment Advisors Pte., which oversees about $350 million, said in an interview from Singapore yesterday. “Investor confidence in India is very low as the economy isn’t showing any signs of improvement. Not too long ago, people were betting interest rates will be cut, totally unaware the rupee would go south like this. In the immediate term, a rate cut is out of question.”

Rate Increase

Policy makers raised two interest rates to help steady the rupee, according to a statement on the central bank’s website late yesterday. The bank increased both the marginal standing facility and the bank rate to 10.25 percent from 8.25 percent.

RBI Governor Duvvuri Subbarao kept the repurchase rate at 7.25 percent in June, after lowering it by 25 basis points each in May, March and January, as the rupee’s plunged threatened to spur inflation. The benchmark wholesale-price index rose 4.86 percent last month, an official report showed yesterday, after a 4.7 percent increase in May that was the smallest since October 2009.

Goldman Sachs pulled forecasts for further reductions in Indian rates in the fiscal year through March 2014 after the rupee fell past 60 per dollar for the first time on June 26. Deutsche Bank dropped its call for a rate cut this month, according to a report dated July 12. The Indian currency, which touched a record low of 61.2125 on July 8, declined 0.4 percent to 59.8950 yesterday.

Industrial Output

“Any further reduction in interest rates can happen only when the rupee stabilizes,” N.S. Venkatesh, the Mumbai-based head of treasury at IDBI Bank Ltd., said in a phone interview yesterday. “The industrial-production numbers show we are slowing down but with the currency at these levels, the central bank may find it difficult to create an ambience for growth.”

Indian investors are betting for the first time since 2011 that borrowing costs will be higher in a year’s time, swaps show. One-year forward contracts, in which rates to be exchanged are agreed on 12 months in advance, have climbed above the price to swap payments immediately for the first time since May 2011, according to data compiled by Bloomberg. The spread is now 16 basis points, compared with minus 28 at the end of March.

The yield on 10-year sovereign notes rose 31 basis points, or 0.31 percentage point, since May 31 to 7.56 percent as global funds cut holdings of local debt by more than $8 billion from a record $38.5 billion on May 21, according to exchange data. The nation’s yield curve was last inverted in 2008, when inflation averaged 8.7 percent and the rupee tumbled 19 percent.

‘Coming to Standstill’

The relatively lower longer-term yields signal expectations that policy makers will resume monetary easing to support growth, according to Peerless Funds Management Co. India’s industrial output shrank 1.6 percent in May from a year earlier, the first contraction in five months, a government report showed on July 12.

“Manufacturing activity is nearly coming to a standstill,” Ganti N. Murthy, head of fixed income in Mumbai at Peerless Funds, which manages the equivalent of $756 million in assets, said in a phone interview yesterday. “The RBI may not cut rates this month but it may choose to maintain an accommodative stance given this slowdown. The long-term view is that rates have to come down.”

Bond risk in India is climbing. The cost to insure the bonds of government-controlled State Bank of India, seen as a proxy for the sovereign, for five years rose 41 basis points in the past three months to 246, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in privately negotiated markets.

“We expect the RBI to stay on the sideline during the July monetary-policy meeting as it would be prudent to wait to see the pass-through impact of the rupee’s correction,” Deutsche Bank economists led by Singapore-based Taimur Baig wrote in the July 12 report. “The best the central bank can do for the time being is to keep liquidity ample and ensure rupee stability.”

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