Global Bond Investors May Be Taking India's Fiscal Promise With a Pinch of Salt

  • Foreign holdings of rupee-denominated debt declined last week
  • `We’re yet to see if the budget actually delivers,' Mirae says

Global bond investors seem to be taking the Indian government’s promise of fiscal consolidation with a pinch of salt as they decide whether to buy more in Asia’s worst-performing debt market.

Foreign holdings of rupee-denominated notes have slumped to an 11-month low even after Prime Minister Narendra Modi’s Feb. 29 budget sparked a rally in bonds and the rupee. While the administration retained a goal to narrow the deficit to a nine-year low and announced lower-than-estimated market borrowings, fund managers say they want to see implementation of the proposals and progress on economic reforms before buying.

“We’re yet to see if the budget actually delivers on promises,” said Kim Jinha, Seoul-based head of global fixed income at Mirae Asset Global Investments Co., which manages about $73 billion worldwide and is still bullish on Indian bonds. “If the government or the central bank isn’t keeping up with promises, we can witness more outflows before they stabilize, but I doubt we’re going to see another huge outflow given that the government has signaled they’ll do something.”

Funds are also watching Reserve Bank of India Governor Raghuram Rajan, who will host an April 5 meeting and had flagged fiscal discipline as one of the pre-requisites for further easing after four interest-rate cuts in 2015. Another box to tick is Modi’s success in pushing through economic changes including a goods-and-services tax that’s currently deadlocked in parliament.

Investors have earned 0.8 percent on rupee sovereign notes so far this year, the least among major Asian markets tracked by Bloomberg. The securities were the region’s top performers in 2015 and 2014, with returns of 8.1 percent and 16.5 percent.

The government aims to borrow 6 trillion rupees ($88.8 billion) in the year starting April 1, lower than the 6.8-trillion rupee median estimate in a Bloomberg survey of 10 analysts conducted before the budget. The 10-year sovereign bond yield dropped the most since October last week, while the rupee capped its biggest gain since September 2013.

“The budget has brought a relief to the market,” said Caroline Gorman, a London-based investment manager at GAM International Management Ltd., whose team manages $4.1 billion in emerging-market debt. “The next issue to focus on will be any progress on reforms like the passage of the GST.”

Even so, some economists are baffled by how much the government has budgeted for a proposed once-in-a-decade salary increase for civil servants, which is estimated to be about 1 trillion rupees. The allocation is crucial to determining the credibility of Modi’s plans to narrow the fiscal gap to 3.5 percent of gross domestic product in the year ending March 2017.

‘Wouldn’t Chase’

Foreign holdings of all rupee bonds, including corporate notes, fell 4.5 billion rupees on Tuesday to 3.36 trillion rupees, after capping a fourth straight week of declines on March 4. The stockpile dropped 87.6 billion rupees in February in the biggest monthly slide since April 2014 amid skepticism over Modi’s commitment to fiscal goals and a broader selloff in emerging-market assets.

Demand for sovereign securities is also being hurt by competition with state-government notes. The average spread between yields on bonds issued by federal and state administrations has widened to about 100 basis points, from around 50 basis points in the last five years, according to Tata Asset Management Co.

Rajeev De Mello, who oversees about $10 billion as head of Asian fixed income at Schroder Investment Management Ltd. in Singapore, said the recent rebound in global oil prices “could be another reason why you’re seeing a little bit of underperformance” from Indian bonds.

“I wouldn’t chase the market right now,” he said, predicting that the central bank will cut the repurchase rate by 25 basis points in April. “We have been positive and positioned already for lower yields.”

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