Bond Bulls Have Most at Stake as India Gets New Central Banker

Urjit Patel to Take Over for Rajan at RBI
  • Rupee, bonds done better under Rajan than two prior RBI heads
  • Bank stocks have outpaced gains in Sensex in past three years

As Urjit Patel prepares to take charge at India’s central bank, investors in the nation’s rupee and bond markets have the most at stake.

That’s because current Governor Raghuram Rajan’s term, which ends Sept. 4, has so far brought them the best pay offs when compared with his two predecessors. Total returns from investing in the rupee outpaced every emerging-market peer other than the Argentine peso. Patel’s reputation as an inflation hawk -- and recent data, which showed consumer price gains had breached the central bank’s upper bound of 6 percent -- may stand the currency in good stead, even as it raises questions about the sustainability of this year’s bond rally.

Investors have heard little from Patel during his three-and-a-half years as deputy governor as he has rarely spoken publicly. The 52-year-old is known for having helped Rajan spearhead the biggest reforms in the Reserve Bank of India’s 81-year history, including implementing an inflation target and cleaning up debt-saddled banks. His first challenges will come almost immediately: managing an outflow of maturing foreign-currency deposits and overseeing the effective operation of the proposed policy-setting panel.

“Bond markets will likely -- at least initially -- view Dr Patel as an even stronger proponent of the current inflation-centric monetary policy framework, and to that extent, will trade cautiously,” said Ananth Narayan, the Mumbai-based regional head of ASEAN & South Asia financial markets at Standard Chartered Plc. “Outside of monetary policy, one will have to wait and see what Dr Patel’s views are, say in the areas of market development, banking health, financial stability.”

Negative Fallout

The yield on notes due January 2026 rose four basis points to 7.14 percent at 10:10 a.m., while the nation’s benchmark stock index dropped 0.2 percent after changing direction at least five times after trading began Monday.

Standard Chartered said in a report it expects a near-term negative impact in the rates market. Government bond yields and swap rates will probably rise, wrote analysts led by Anubhuti Sahay, head of the bank’s South Asia economic research. A new rate-setting panel, set to be formed in the coming months, is mandated to keep consumer-price inflation at the target of 4 percent, plus or minus two percentage points.

The following charts track the performance of Indian assets under Rajan and his predecessors Duvvuri Subbarao and Y.V. Reddy, as well as the central bank’s recent build-up of currency reserves which helped reduce volatility in the rupee.

Reviving Confidence

CHART 1: Rajan’s term revived confidence in India’s rupee and bonds. Taking charge within days of the currency’s tumble to a record low during the taper tantrum of 2013, one of his earliest policy moves was to open a currency-swap window to attract U.S. dollars, helping stabilize the currency. He also lowered the benchmark rate five times over his term while emphasizing a focus on inflation. One of Patel’s first challenges as governor will be to contend with an estimated $20 billion outflow from maturing foreign-currency deposits, starting in September, that Rajan had lured to support the currency.

CHART 2: India’s management of foreign-currency reserves under Rajan bucked the prevailing trend as the nation’s warchest swelled to a record in August. China, Brazil and Russia have depleted their holdings over that period. India’s continued dollar buying has supported a gradual weakening of the rupee. A certain amount of depreciation “is necessary” until inflation comes down, Rajan said on Feb. 13. The RBI will “continue to contain volatility in the exchange rate but keep a neutral view on its direction,” Goldman Sachs Group Inc. analysts including Singapore-based Nupur Gupta wrote in a report Aug. 21.

CHART 3: The Indian rupee led the world when it came to declines in expected volatility over the past three years as a build-up of reserves curbed currency swings. Standard Chartered said in its Aug. 21 report that Patel will continue the RBI’s apparent preference for wanting to contain undue volatility.

CHART 4: A crackdown on bad loans notwithstanding, banking shares had their best show under Rajan. During his tenure the 10-member S&P BSE India Bankex rallied 121 percent, more than double the 51 percent advance in the benchmark S&P BSE Sensex. Most private lenders in the Bankex at least doubled during Rajan’s tenure with Yes Bank Ltd. soaring 465 percent. Punjab National Bank and ICICI Bank Ltd. were among the laggards, climbing 55 percent each.

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