Modi Shock Ban Boosts Bonds as Biggest Fund Eyes Rate Cuts

  • Yields may touch levels not projected so far: ICICI Prudential
  • Bond investors must ‘stay put’ for further six months: Naren

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India’s biggest money manager is bullish on local bonds as it expects the government’s crackdown on unaccounted wealth opening up room for more interest-rate cuts.

Prime Minister Narendra Modi’s surprise clampdown on high-value currency notes late Tuesday will suck out about 86 percent of the 17.8 trillion rupees ($268 billion) of cash in circulation, official estimates show. With the old notes to be deposited in banks by the end of December, there’s optimism that increased financial-system liquidity will help drive down money-market rates.

Even “if 5 trillion rupees worth of cash comes back into the banking system, it is equal to six months of deposits, which is massive,” said S. Naren, executive director and chief investment officer at Mumbai-based ICICI Prudential Asset Management Co., which oversees the equivalent of $29 billion. “There could be a considerable drop in interest rates over the next three to six months.”

Slowing inflation allowed a panel led by Reserve Bank of India Governor Urjit Patel to cut the benchmark rate to the lowest in more than five years last month as authorities look to sustain growth in the world’s fastest-expanding major economy. A further reduction would help kick-start stalled infrastructure projects, Naren said.

The yield on India’s benchmark 10-year sovereign bonds, which plunged 13 basis points on Wednesday, fell one basis point to 6.66 percent on Thursday, the lowest close since June 2009.

Investors seem to have grown more optimistic following Modi’s measures. The 10-year yield is seen sliding to 6.40 percent by March 31, based on the median estimate in a Bloomberg survey of 10 fixed-income dealers and money managers conducted Wednesday. That compares with a forecast of 6.50 percent in a similar survey held after last month’s rate cut.

‘Attractive Again’

Yields may decline to “levels which one may not have projected thus far over the next six months,” said Naren. “Fixed income appears attractive again.” ICICI Prudential Long Term Plan, which invests in a range of debt instruments, has returned 15 percent in the past year, beating 99 percent of its peers, data compiled by Bloomberg show.

Interest-rate swaps show the cost to lock in borrowing costs for a year declined 20 basis points over the past two days to 6.15 percent.

Investors have earned 8.7 percent on rupee sovereign debt over the past six months, the most in emerging Asia, Bloomberg indexes show. Local notes and the rupee are likely to beat Asian peers in the near term, Goldman Sachs Group Inc. analysts led by Timothy Moe wrote in a report Wednesday.

Five hundred rupee and 1,000 rupee notes have ceased to be legal tender from Wednesday. The step is an attempt by Modi to fulfill his election promise of recovering illegal income, locally known as black money. Mumbai-based brokerage Edelweiss Securities Ltd. predicts the crack down will uncover 3 trillion rupees in black money. ICICI Securities Primary Dealership Ltd. is even more optimistic, pegging the figure at as much as 4.6 trillion rupees.

“Our advice to investors would be to stay put for another six months and ride the entire interest-rate drop cycle,” said Naren. “Over the next three years, we expect a boom in the Indian economy backed by capital expenditure cycle, starting 2018.”

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