Rajan Gives Rupee Bond Bulls Confidence to Forecast End of Rout

  • Ten-year yield to drop to 7.55 percent by end-March: survey
  • Mobius sees ‘lot of room’ for Indian central bank to cut rates

Reserve Bank of India Governor Raghuram Rajan gave Indian bond bulls confidence to forecast an end to a two-month jump in yields.

Even as he left benchmark interest rates unchanged on Tuesday, Rajan said inflation risks are to the downside and he "will use the space for further accommodation, when available." That triggered the biggest rally in sovereign notes in two months. The benchmark 10-year yield, at 7.71 percent Wednesday, will drop another 16 basis points by March 31, a Bloomberg survey of 10 fixed-income dealers and fund managers shows. It surged 25 basis points in the previous two months, the most since the period ended September 2013.

Deutsche Asset Management India Pvt. and Standard Chartered Plc are among those predicting rupee debt can withstand the prospect for higher U.S. borrowing costs that prompted outflows of foreign funds last month. Citigroup Inc. says the RBI could cut rates right after India’s federal budget, typically in February, should Prime Minister Narendra Modi’s government stay on course to narrow the deficit.

“The 10-year has room to rally despite some near-term headwinds because of the Federal Reserve,” said Kumaresh Ramakrishnan, Mumbai-based head of fixed income at Deutsche Asset, which manages 207.2 billion rupees ($3.1 billion). “We don’t classify the RBI’s policy as hawkish. Yields should be lower by March, at around 7.40 percent-7.50 percent.”

Bond Yields and Foreign Holdings of Rupee Debt This Quarter
Bond Yields and Foreign Holdings of Rupee Debt This Quarter

Consumer prices rose 5 percent in October, matching the RBI’s target for March 2017. Rajan’s inflation fight has been complicated by a proposed increase in salaries of millions of federal government employees that could boost consumption and derail plans to curb the deficit to 3.9 percent of gross domestic product in the year ending March 2016 and to 3.5 percent the following year.

The RBI will pay close attention to food and oil prices while tracking inflationary expectations and external developments, and monitor the implementation of the proposed pay raise that risks stoking prices, according to its statement Tuesday. The monetary authority, which will next review rates on Feb. 2, is prepared to act outside policy dates if warranted, Rajan said during the post-policy press conference.

‘Decidedly Dovish’

“The RBI is confident of fiscal consolidation and assesses the balance of risks for the inflation outlook to be to the downside,” Citigroup economists led by Samiran Chakraborty in Mumbai, wrote in a note. “This stance is decidedly dovish relative to current market pricing. We expect investors’ optimism will grow alongside lower global oil prices. We expect lower yields and a stronger rupee in response,” they wrote.

Foreign holdings of sovereign and corporate debt fell 46.9 billion rupees in November, the most since May, amid increased odds that the Federal Reserve will raise interest rates at its Dec. 15-16 meeting. The rupee weakened 2.1 percent in Asia’s worst performance while the S&P BSE Sensex index of Indian shares declined 1.9 percent in its biggest monthly slide since August.

More Easing

The lack of clarity on U.S. rates is holding back markets and buying should come back to emerging markets once Fed risks subside, Franklin Templeton’s Mark Mobius said in an interview to Bloomberg TV India Tuesday, adding that there is a “lot of room” for the RBI to cut borrowing costs.

Overseas holdings of Indian debt rose Tuesday for the first time in six days, according to data from the National Securities Depository Ltd. Ten-year bonds advanced in Mumbai for a second day on Wednesday, pushing the yield to a one-week low.

Rajan has taken advantage of a global commodity slump to slash the repurchase rate 125 basis points this year to 6.75 percent, including a larger-than-estimated 50 basis point reduction in September.

“Indian bonds will remain well-supported given that the RBI continues to maintain an accommodative monetary policy,” said Nagaraj Kulkarni, Singapore-based senior Asia rates strategist at Standard Chartered. “We expect the inflation dynamics to remain supportive and our forecast for the 10-year yield is 7.30 percent by end-March.”

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