India’s bond bulls are betting plunging oil prices and a late burst of monsoon rain will keep inflation in check, giving the central bank room for interest-rate cuts.
The benchmark 10-year yield will drop 30 basis points by year-end from Wednesday’s 7.80 percent, the median estimate in a Bloomberg survey of 17 fixed-income dealers and fund managers shows. The yield has fallen just six basis points this year even as Reserve Bank of India Governor Raghuram Rajan lowered borrowing costs three times and global funds raised their holdings of local notes.
DSP BlackRock Investment Managers Pvt., the local venture of the world’s largest money manager, and JPMorgan Asset Management India Pvt. say July’s 17 percent drop in Brent crude is a boost for the net oil-importing nation. A late pick-up in seasonal showers this month eased concern over crop output, which may help slow gains in consumer prices from June’s nine-month high and encourage Rajan to resume easing.
“The crash in commodity prices is hugely positive for the overall inflation trajectory,” said Ritesh Jain, Mumbai-based head of fixed income at Pramerica Asset Managers Pvt., a unit of Prudential Financial Inc. that oversees 21.3 billion rupees ($333 million) locally. Slowing inflation will prompt the RBI to cut rates by another 25 basis points this year and that will drive bond yields lower, he said.
Sixteen of the survey participants expect the central bank to leave the repurchase rate unchanged at 7.25 percent at its Aug. 4 policy review after data this month showed inflation accelerated to 5.40 percent in June. Rajan has pared the rate by 75 basis points in 2015 with the latest reduction on June 2.
Even so, bonds slumped last month, with the 10-year yield climbing 22 basis points in the biggest advance August 2013 amid a global selloff in sovereign bonds and as the crisis in Greece worsened. The yield has fallen six basis points in July as oil prices dropped, the turmoil in Greece eased and the weather bureau forecast more rains.
A Bloomberg index of commodities sank to a 13-year low this month, with Brent crude slipping into a bear market. That’s improved the inflation outlook for Asia’s third-largest economy, which imports about three quarters of its oil.
“The fall in commodity prices, including crude, will be incrementally positive for India and help keep inflation under control,” said Dhawal Dalal, Mumbai-based head of fixed income at DSP BlackRock Investment, which manages 372.3 billion rupees. Mumbai-based Dalal predicts the 10-year yield could drop as low as 7.40 percent by the end of the year.
Governor Rajan has flagged deficient rains, oil prices and external volatility as inflation risks. Santosh Kamath, the chief investment officer for fixed income at Franklin Templeton Asset Management India Pvt. and the best-performing Indian fund manager for the first half of 2015, said this month that an increase in interest rates by the Federal Reserve is the biggest potential threat for local bonds.
Indian notes have also been weighed down by concern the central bank’s resolve to control inflation may see it stepping up open-market sales of government debt to drain excess cash from the banking system, a move that PNB Gilts Ltd. says could hurt demand for existing securities and disrupt the government’s plan to borrow 6 trillion rupees in the year ending March 2016.
“There’s enough supply in the bond markets to keep yields elevated,” said Vivek Rajpal, a rates strategist in Singapore at Nomura Holdings Inc., who doesn’t expect Rajan to lower borrowing costs this year. “Continuous supply and uncertain monsoons” are risks for government notes, he said.
One-year interest-rate swaps have dropped 10 basis points in July to 7.44 percent, showing traders are pricing in more easing. Credit-default swaps insuring the notes of State Bank of India, a proxy for the sovereign, declined five basis points this month to 167, according to data provider CMA.
The 51 percent drop in crude oil over the past year has been key to consumer inflation slowing from as high as 8.60 percent in January 2014 and JPMorgan Asset says falling commodity prices are supportive.
“Indian government bonds are positioned positively on the fundamental and valuation fronts,” said Namdev Chougule, its head of fixed income in Mumbai. “We expect another 25-50 basis points cut in the repo rate over the next six months.”