India Debt Sale Failure Shows Waning Appetite as Foreigners Flee

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If this month’s $1.4 billion withdrawal by global funds isn’t enough to signal faltering demand for Indian bonds, here’s more evidence.

An auction of treasury bills failed for the first time since February on May 13, while underwriters had to rescue an offering of sovereign notes two days later in the first such forced purchases since August. A sale of 2026 government bonds on May 15 saw the least bids as a proportion of debt on offer since they were first sold in November.

Appetite is waning as a rebound in oil prices coupled with the prospect of weak monsoon rains clouds the outlook for cooling inflation and interest-rate cuts. Indian sovereign bonds are the worst performers among the largest emerging markets this quarter amid a global rout. Overseas funds have turned net sellers in May after 12 straight months of purchases.

“There’s clearly a lack of appetite and investors are hesitant to add more positions,” Badrish Kulhalli, a fixed-income fund manager at HDFC Standard Life Insurance Co. in Mumbai, which manages about 670 billion rupees ($10.5 billion), said in a phone interview Tuesday. “There’s a risk of failure to meet targets at some more auctions.”

Investors in Indian government notes lost 0.03 percent this quarter, compared with returns of 7.3 percent in Russia, 2.5 percent in Brazil and 1.3 percent in Chinese securities, JPMorgan Chase & Co. indexes show. Indian debt was the best among so-called BRIC nations in 2014.

Risk Premium

The Reserve Bank of India didn’t accept any of the 73 bids worth 151.17 billion rupees it received at a targeted sale of 60 billion rupees of 364-day bills last Wednesday, amid speculation the central bank wasn’t comfortable with higher rates. For 91-day notes, it accepted 60.96 billion rupees of offers, short of the 80-billion rupee goal.

Two days later, primary dealers had to buy 27.09 billion rupees of unsold sovereign bonds at a 160-billion rupee auction of four securities maturing between 2020 and 2044. The bid-cover ratio for the 2026 notes, the most-issued debt at auctions this year, fell to 2.16 times the amount offered at that sale, from 2.82 at the previous auction.

“There is appetite, but at a price,” said Soumyajit Niyogi, a Mumbai-based interest-rate analyst at primary dealer SBI DFHI Ltd. “While the government would like to sell the bonds at the cheapest cost, investors are seeking a much higher risk premium in the current environment of global volatility.”

India met its target to sell 150 billion rupees of 91- and 182-day treasury bills at Wednesday’s auction.

Inflation, Rates

The government plans to sell four bonds totaling 160 billion rupees, including 90 billion rupees of a new 10-year security, on May 22, the RBI said in a statement on Tuesday.

The optimism around domestic bonds in the past year had much to do with the plunge in Brent crude prices, which helped slow consumer-price gains, allowing the central bank to cut benchmark interest rates twice in the first quarter of 2015.

With crude surging 18 percent this quarter, there’s a risk that import costs for India, which gets about three-fourth of its oil from overseas, may climb. At the same time, the weather department’s forecast for a below normal June-September monsoon season threatens to hurt farm output and stoke food costs, which could further limit the central bank’s room for easing.

The RBI will consider factors including the “likely strength” of monsoon rains before deciding on future actions, Governor Raghuram Rajan said in the latest policy statement on April 7, when he kept the benchmark repurchase rate unchanged.

Benchmark 10-year yields have risen 10 basis points since March 31 to 7.84 percent, after falling for five straight quarters, data compiled by Bloomberg show.

‘Nothing Wrong’

Kotak Mahindra Asset Management Co. says the rise in yields is temporary and the announcement of a new 10-year note will help revive sentiment.

“Bond losses have largely been led by global factors and there’s nothing wrong with fundamentals,” said Lakshmi Iyer, chief investment officer for debt at Kotak Mahindra in Mumbai.

Even so, local investors are exiting fixed-income funds at the fastest pace since September, a sign of more losses ahead for bonds. The plans saw an outflow 25 billion rupees in April, a third straight month of withdrawals, data from Association of Mutual Funds in India show.

Inflows into so-called gilt funds, which invest solely in sovereign debt, slowed to 1.64 billion rupees in April, the smallest since September, according to AMFI data.

Bond risk in India is rising. Credit-default swaps insuring the notes of State Bank of India, a proxy for the sovereign, against non-payment for five years have risen to 151 basis points from a five-year low of 143 in March, according to data provider CMA.

“Investors will demand more yields,” said Arvind Narayanan, head of sales, treasury and markets at DBS Bank Ltd. in Mumbai. “Any body who now puts money in the fixed-income market would like to be compensated for it.”

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