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Bond Bull Looks for Dark Clouds to Salvage Monsoon: India Credit

June-September Monsoon
A worker carries a sack of vegetables in the monsoon rain at the Vashi Agricultural Produce Market Committee (APMC) wholesale market in Mumbai, India, on Saturday, July 12, 2014. The June-September monsoon rains have so far been 36 percent below the 50-year average, delaying planting of some crops and threatening to push up food costs that account for about half of India’s consumer-price index. Photographer: Dhiraj Singh/Bloomberg

Sankaran Naren studies the Indian weather bureau’s website about four times a day to help decide the bond-buying plans for the $20 billion of funds he oversees.

“Government bond valuations are attractive, but given that the monsoon hasn’t been good so far, there’s scope to have a better entry point,” Naren, the 48-year-old chief investment officer at ICICI Prudential Asset Management Co., said in a July 16 interview in Mumbai. “Bonds have a phenomenal opportunity if the monsoon picks up.”

The June-September monsoon rains have so far been 36 percent below the 50-year average, delaying planting of some crops and threatening to push up food costs that account for about half of India’s consumer-price index. Rupee-denominated debt handed investors annual losses just twice in the last decade, according to HSBC Holdings Plc data. Sovereign notes lost 4.9 percent in 2009 amid the driest monsoon in almost four decades, and 3.9 percent in 2004, when rains were about 14 percent below normal.

Reserve Bank of India Governor Raghuram Rajan, who raised borrowing costs three times since taking charge in September, signaled last month he’d lower them if inflation cooled faster than his estimate for a drop to 8 percent by January 2015. India’s CPI rose 7.31 percent from a year earlier in June, the least since the gauge was created at the start of 2012.

Top Fund

ICICI Prudential, India’s second-largest asset manager, oversees the best-performing local fixed-income fund. The ICICI Prudential Long Term Fund returned 8.93 percent so far in 2014, the most among 181 top-rated open-ended debt investment plans tracked by New Delhi-based data provider Value Research India Pvt. Escorts Short-Term Debt Fund was second with 6.99 percent and Tata Dynamic Bond Fund ranked third with 6.82 percent.

The RBI is expected to lower its benchmark repurchase rate by 25 basis points, or 0.25 percentage point, to 7.75 percent by the second half of 2015, according to a Bloomberg survey of economists. India’s new government projected this month that economic growth would quicken to as much as 5.9 percent in the year ending March 2015, from the previous period’s 4.7 percent that was near the slowest in a decade.

“India is one of the very few countries in the world where you’ll see growth improving and interest rates falling in the next three years,” Naren said in his office in suburban Mumbai. “At the moment, bonds are pricing in a moderately bad monsoon. They aren’t prepared for a normal monsoon.”

El Nino

Seasonal showers will be 7 percent below average in India this year because of the potential emergence of an El Nino, the India Meteorological Department predicts. In 2009, the last time India experienced the weather pattern, rainfall fell short by 22 percent, reducing grain output and leading to faster inflation, official data show.

“Signs of a deficient monsoon and weak acreage have increased the risks of a repeat of the 2009 phase of high food inflation,” Kotak Mahindra Bank Ltd. economists including Indranil Pan in Mumbai, wrote in a July 14 report. “Given the risks of higher price pressures over the next few months, we maintain our call for an extended pause in policy rates.”

Government bonds offer an attractive investment opportunity as long as the annual shortfall in seasonal showers doesn’t “significantly” exceed 10 percent, according to Naren.

Indian government bonds returned 7.4 percent so far this year, the most among Asian local-currency fixed-income markets tracked by Bloomberg. Chinese securities handed investors 5.1 percent and those in Indonesia earned 7 percent.

‘Structural Story’

While India’s strongest election result since 1984 and a stable rupee fueled bond gains in the first half, yields have risen from this year’s low in June amid concerns over the monsoon and living costs. The rate on the 8.83 percent debt due November 2023 climbed seven basis points in the past month to 8.75 percent, while the rupee appreciated 0.1 percent to 60.34 per dollar.

Prime Minister Narendra Modi’s sweeping election victory in May has buoyed optimism among money managers including Reliance Capital Asset Management Ltd. that he will deliver on campaign promises on steps to rein in prices. Modi pledged to crack down on food hoarders, create a national farm market and improve rural infrastructure to cool inflation.

“As of now, there is a bigger, structural story that the markets are looking at and that includes bringing down inflation and inflation expectations over the next 12-18 months,” Amit Tripathi, head of fixed-income investments in Mumbai at Reliance Capital, India’s third-biggest fund manager, said in an interview on July 16. “Structural reforms would mean that longer-term bonds perform better. I hope to see the 10-year yield closer to 8 percent by the end of 2014.”

Monsoon Fixation

Tripathi, like Naren, is bullish on government bonds and prefers them to corporate notes. “Our debt portfolio is clearly loaded in favor of government bonds” as they offer better liquidity and “are more richly priced,” he said.

Naren’s fixation with the monsoon underscores its importance for growth and living costs in Asia’s third-largest economy, where the World Bank estimates two-thirds of the 1.2 billion people live on less than $2 a day. The four-month spell accounts for more than 70 percent of the annual rains in India, where agriculture makes up 14 percent of the gross domestic product with an estimated 833 million people dependent on the sector for livelihood.

While bonds fell in June, the S&P BSE Sensex, India’s benchmark stock index, climbed for a fifth straight month, rallying 4.9 percent. The 30-stock gauge ended at 26,100.08 on July 7, a record close.

“Equities are fair value if you look three years ahead, but bonds are deep value even today,” Naren said. “The monsoon is the No. 1 factor for fixed-income markets at the moment as it will have an impact on inflationary expectations, which in turn will impact the central bank’s view. The weather bureau’s website is on my favorites bar.”

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