Nomura Bullish After Rajan Vigilance Drives Rally: India

Nomura Holdings Inc. is betting Indian 10-year bonds will extend gains, after their best quarter in more than a year, as fund managers say the central bank is on track to tame Asia’s worst inflation.

The yield on the benchmark 10-year sovereign notes fell 24 basis points in the three months ended Sept. 30, the most in five quarters, while that on similar Indonesian debt rose. Reserve Bank of India Governor Raghuram Rajan kept the benchmark repurchase rate at 8 percent for the fourth straight meeting yesterday, and said that while price risks are “still to the upside,” they’ve receded since a review in August.

Nomura and IDFC Asset Management Co. say they are confident the RBI will meet its 2016 inflation target of 6 percent, even as Rajan said unforeseen developments could undermine the goal. A pick-up in monsoon rains and lower crude oil costs have eased price concerns, prompting Goldman Sachs Group Inc. to scrap its forecast for a rate increase this year.

“We remain bullish on government bonds as we expect the RBI to succeed in meeting the 2016 target,” Suyash Choudhary, Mumbai-based head of fixed income at IDFC Asset, which manages 438 billion rupees ($7.1 billion), said in a phone interview yesterday. “Even in the absence of a rate cut, we think more confidence with respect to the inflation trajectory will ensure that term premia on the yield curve continue to shrink.”

As 10-year notes rallied last quarter, those maturing in 12 months fell, suggesting investors don’t expect an RBI rate cut soon. The one-year yield rose 27 basis points, or 0.27 percentage point, in the last three months to 8.67 percent, data compiled by Bloomberg show. That led to a premium for the shorter debt over 10-year bonds of 16 basis points.

Policy Outlook

Nomura predicts the 10-year yield will drop to 8.25 percent by the end of March from 8.49 percent today, while Kotak Mahindra Asset Management Co. forecasts a “near term” range of 8.25 percent to 8.50 percent.

Prime Minister Narendra Modi has pledged to cut the budget deficit to a seven-year low, boosting confidence among global investors, who pumped a record $19.6 billion into corporate and sovereign notes this year. Gains in the consumer-price index slowed to 7.8 percent in August from as much as 11.2 percent in November, official data show. Inflation was 2 percent in China, 1.4 percent in South Korea and 3.99 percent in Indonesia in the same month.

“Lower commodity prices, expected disinflation and prospects of fiscal consolidation are putting downward pressure on rates at the longer end,” Vivek Rajpal, a Singapore-based rates strategist at Nomura, said in an e-mail interview. “Outlook remains very positive on longer-end bonds.”

Price Risks

While inflation has eased, economists at Goldman Sachs and Credit Suisse Group AG say price risks still remain elevated and the RBI is more likely to increase interest rates than cut them.

“Many things have to go right, from food-price developments to government’s fiscal policies, for inflation to come down to 6 percent by January 2016,” Santitarn Sathirathai, a Credit Suisse economist in Singapore, wrote in a report yesterday. “Food price remains a threat.”

Rajan joined counterparts from Russia and Brazil in holding interest rates last month as he seeks to reduce entrenched price pressures to lay the foundation for sustainable growth. India’s economy expanded 5.7 percent from a year earlier in the April-June quarter, the most in about two years, official data show. Expansion is estimated at 5.5 percent in the year through March 2015 and 6.3 percent the following year, the RBI’s Monetary Policy Report said.

Rupee Shielded

Delaying rate reductions has allowed Rajan to shield India’s currency against potential increases in U.S. borrowing costs. The rupee’s 1 percent advance in 12 month is the best performance among 11 Asian exchange rates tracked by Bloomberg. It fell 0.1 percent to 61.8375 per dollar today, and has rebounded 11.4 percent from an unprecedented low in August 2013.

India has used the rupee’s strength to boost foreign-exchange reserves, Rajan said yesterday. The stockpile stood at $316 billion on Aug. 19, up from about $275 billion in August last year when the RBI sold dollars to buoy the rupee from the record low reached after the Federal Reserve first signaled it would begin paring its record stimulus.

The RBI cut liquidity provided under the export credit refinance facility to 15 percent of eligible export credit outstanding from 32 percent, according to yesterday’s policy statement. It said it will lower the amount of bonds that banks can hold without marking to market in cuts of 50 basis points between January and September 2015 “to further develop the government securities market.”

Bond Ceiling

Rajan took further steps to buffer the rupee after the Fed projected a steeper increase in U.S. borrowing costs next year. The RBI yesterday raised the amount of government bonds that banks can hold as High Quality Liquid Assets, which can be used to borrow emergency funds when market conditions call for liquidity additions, and allowed importers to hedge more of their foreign-currency payments.

The 10-year yield will probably drop to 8.20 percent by March 31, according to median forecast of 10 traders and fund managers in a Sept. 23 Bloomberg News survey. The highest estimate was 8.50 percent and the lowest 8 percent.

“The central bank seems reasonably confident of achieving its inflation targets,” Lakshmi Iyer, head of fixed income at Kotak Mahindra Asset Management in Mumbai, said in a phone interview yesterday. “We remain bullish on government bonds.”

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