Photographer: Dhiraj Singh/Bloomberg

Citibank Looks Past India Inflation Breach as Bonds Rally

  • Ten-year yield could drift toward 7 percent: Chakravarthy
  • ICICI Bank’s Kumar sees a 25-basis point rate cut by March 31

Citibank is predicting Indian sovereign bonds will extend a rally that’s driven benchmark yields to seven-year lows and a recent inflation spike will cool toward the end of the year.

The Reserve Bank of India’s regular cash infusions into the banking system and the global hunt for yield should support demand for debt, according to Badrinivas Nallan Chakravarthy, Mumbai-based head of local markets treasury at the U.S. bank. Consumer prices in July breached the upper bound of the RBI’s target range, rising the most in 23 months.

Indian bonds joined the global debt surge in July, with benchmark notes gaining the most in more than three years, as speculation mounted the nation’s new central bank chief will lean toward looser monetary policy. Yields still remain the highest among major Asian nations, attracting investors including South Korea’s National Pension Service, which said this month it plans to put some of its 533 trillion won ($480 billion) of assets into India.

“Most of the positive factors which have driven the recent bond rally continue to be in play,” Chakravarthy said in an interview. “Hence, there is limited risk of a sharp selloff and 10-year yields could drift lower toward 7-percent levels.”

Chakravarthy expects consumer inflation to “moderate progressively,” as abundant June-September monsoon rains boost crop output and help contain food prices that have a significant bearing on living costs. That should create room for a 25-basis point reduction in the benchmark repurchase rate at the RBI’s October or December policy review, he said, predicting that CPI will ease toward the central bank’s 5 percent target by March 2017.

Governor Raghuram Rajan left the repo rate at a five-year low of 6.50 percent on Aug. 9, the last review before his term ends on Sept. 4. The monetary policy stance remains accommodative, he said, while flagging upside risks to inflation.

“The RBI’s commitment in the latest policy to provide liquidity on a proactive basis means open-market operations of bonds are now likely to occur regularly,” Chakravarthy said. “Any upside surprise in inflation is something to watch out for.”

Emkay Global Financial Services Ltd. predicts the RBI will pause on rates “for long” after CPI rose 6.07 percent last month from a year earlier. The consumer food-price index jumped 8.35 percent. Faster inflation won’t derail the bond market’s rally as it is “hinged to expectations of softer global monetary stance and continued liquidity glut,” IDFC Bank Ltd. Chief Economist Indranil Pan wrote in a report dated Aug. 12.

The central bank has injected about 900 billion rupees ($13.5 billion) through debt purchases since the start of the financial year on April 1, improving cash supply at banks. Foreign investors raised holdings of rupee-denominated government and corporate notes by 69.5 billion in July, the most in nine months.

India’s 10-year yield is the highest among major Asian markets despite falling three basis points this month and 28 basis points in July, the most since May 2013. Its close of 7.08 percent on Aug. 11 was the lowest since Sept. 2009, making investors including Peerless Funds Management Co. and DBS Bank Ltd. skeptical about further gains. The yield rose four basis points to 7.14 percent in Mumbai on Thursday.

There’s still a possibility of another 25-basis point reduction in the benchmark rate in the year ending March 31, according to Shilpa Kumar, group executive for markets and proprietary trading at ICICI Bank Ltd., India’s largest private lender by assets. That’s “provided the inflation trajectory plays out and assuming there are no shocks,” she said in an interview in Singapore.

Rupee Outlook

The rupee has weakened one percent this year, heading for its sixth annual decline, as the central bank’s accumulation of foreign-exchange reserves adds pressure on the currency. It fell 0.1 percent to 66.81 per dollar on Thursday.

Citibank, part of the world’s largest currency trader Citigroup Inc., sees the currency depreciating gradually over nine to 12 months, “unless the dollar cycle shifts substantially or the new RBI governor ushers in substantial changes in the exchange-rate policy,” Chakravarthy said.

“The rupee will eventually move towards depreciation,” said Kumar of ICICI Bank. “Our economists are looking at the rupee trending towards 70 by the end of the fiscal year.”

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