India’s surprise decision to boost borrowing costs just two months after cutting them has erased the biggest bond gains among the top four emerging markets, fueling bets $8 billion in fund outflows will be extended.
The yield on 10-year sovereign notes surged 55 basis points in the past two days to 8.12 percent, the highest level this year, after the Reserve Bank of India raised two of its interest rates by 2 percentage points each on July 15, while keeping its benchmark repurchase rate unchanged. All three measures were lowered in May, March and January. The 10-year yield is up seven basis points in 2013 after reversing earlier declines, compared with a six basis point increase to 3.65 percent in China.
Global funds trimmed holdings of rupee debt by $8.5 billion from a record $38.5 billion in May as an 8.6 percent tumble in the rupee since March hurt returns. Before yesterday’s rout, Indian bonds were this year’s best performers in local-currency terms among the BRIC nations, with a 6.2 percent gain that topped China’s 1.4 percent, Russia’s 1.8 percent and Brazil’s 15.5 percent loss, JPMorgan Chase & Co. data show.
“The confidence of investors has been dwindling because of global market conditions and India’s weakening domestic situation,” Walter Rossini, a fund manager in Milan for Aletti Gestielle Sgr SpA, said in an interview yesterday. “Monetary policy in India won’t ease in the coming months and therefore foreign-fund outflows may intensify. The outflows are despite the efforts of policy makers, which means the undertone is weak and any further measures may have an insignificant impact.”
With the rate increases, RBI Governor Duvvuri Subbarao joins policy makers from the largest emerging markets in reining money-market liquidity to stem currency losses and ensure stability in the financial system. Brazil raised its benchmark rates three times this year and a cash squeeze in China sent interbank borrowing costs to records last month.
After increasing the bank rate and the marginal standing facility rate to 10.25 percent from 8.25 percent, the RBI plans to drain cash from markets by selling 120 billion rupees ($2 billion) of government debt at an open-market auction tomorrow. In addition, the monetary authority said it will cap its daily fund injections via repurchase contracts, meant to help lenders meet shortages, to about 750 billion rupees, compared with a daily average of 882 billion rupees availed by banks this year.
The central bank last raised any of its rates in October 2011, when inflation was close to 10 percent. The pace of gains in the benchmark wholesale-price index quickened for the first time in six months in June to 4.86 percent as a falling rupee made imports costlier, from a 43-month low of 4.7 percent in May, official data show.
Cooling inflation in the first five months allowed Subbarao to cut interest rates by 75 basis points, or 0.75 percentage point, to counter an economic slowdown. The reductions took the repo rate to the current level of 7.25 percent. Asia’s third-largest economy expanded 5 percent in the fiscal year ended March 31, the least in a decade, government data show.
International investors reduced ownership of Indian bonds in each of the last eight weeks as the U.S. signaled it will scale back stimulus and amid concern India will tighten policies to support the rupee. The RBI’s tightening measures may push up yields further and the South Asian nation may unveil more steps to stabilize markets, according to Goldman Sachs Group Inc.
“The measures constitute a shift in monetary stance from pause to tightening,” Tushar Poddar, a Mumbai-based economist at Goldman Sachs, wrote in a research note yesterday. “The longer end of the yield curve can move up due to the RBI selling government bonds, while the short end will be negatively impacted by the quantitative restrictions on the repo window. We think that other measures, including capital and import controls, are on the table.”
The yield on 10-year sovereign notes has climbed 101 basis points from a 44-month low of 7.11 percent reached in May, widening the spread over similar-dated U.S. Treasuries to 559 basis points, according to data compiled by Bloomberg. An auction of fixed-income purchase permits to foreigners on June 20 failed to meet targets for the first time since October.
The prospect of rupee losses rekindling inflation has cut room for monetary easing in India even as Goldman Sachs to Nomura Holdings Inc. say growth in the $1.9 trillion economy will miss forecasts this fiscal year.
India’s sovereign bond yield curve was the most inverted on record yesterday after the RBI’s measures, a sign investors expect more economic weakness. The yield on two-year notes has jumped 147 basis points since May 31 to 8.79 percent, 67 basis points more than 10-year debt. In China, securities due in a decade offer 34 basis points more than two-year ones.
This week’s rate increases by the central bank are meant only to stabilize the exchange rate and don’t signal a change in the nation’s pro-growth policies, Finance Minister Palaniappan Chidambaram told reporters in Jaipur yesterday.
“These measures should not be read as a prelude to any policy rate changes,” he said. “These measures in no way affect our commitment to growth. The measures are taken to quell excessive speculation and stabilize the rupee.”
India’s resolve to support the rupee and the recent increases in yields make the nation’s bonds more attractive, according to Pictet Asset Management SA, which manages $30 billion of emerging-market debt.
“The RBI is preparing to take the necessary pain,” Philippe Petit, a Singapore-based senior investment manager at Pictet Asset, said in an interview yesterday. “It is preparing to avoid a situation where the currency gets out of control and they are putting everything behind themselves. The long end still looks attractive and it looks like a good buying opportunity.”
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 40 basis points in the past three months to 248, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in privately negotiated markets.
Standard Chartered Plc cut its government bond portfolio in India to underweight from neutral after the RBI steps, according to a research report published yesterday. The overnight interbank borrowing rate in Mumbai surged as high as 9.25 percent yesterday, compared with an average 6.96 percent in the past month, according to data compiled by Bloomberg.
“The measures shocked the rates market,” analysts including Mumbai-based Samiran Chakraborty wrote in the report. “The liquidity deficit will likely persist, implying elevated overnight rates and funding costs for government bond investors.”