Modi Cash Ban to Fuel Bond Gains After Best Year Since 2008

Updated on
  • Amundi, OppenheimerFunds among those interested in rupee debt
  • HSBC Global sees 75-basis points cut in key rate by Feb. 2018

Indian sovereign bonds look poised to extend 2016’s Asia-beating rally in the new year with interest-rate cuts expected in a banking system already flush with cash.

A stable currency and the second-highest yields among the region’s major markets are keeping investors including Amundi Asset Management and OppenheimerFunds Inc. interested in rupee debt. That’s even as the benchmark 10-year yield has dropped for a third year, with 2016’s 128-basis point decline set to be the steepest in eight years. It will fall to 6.23 percent by March 31, from 6.48 percent on Tuesday, shows the median estimate in a Bloomberg survey of analysts.

Calls for monetary easing have intensified with consumer inflation slowing to a two-year low and growth in Asia’s third-largest economy seen taking a hit from the government’s decision of banning high-value currency to crack down on unaccounted wealth. Bonds have proved to be an unintended beneficiary because as citizens rushed to banks to deposit the defunct bills, lenders flooded with cash have parked a part of the funds in debt.

“We continue to like India’s rates markets,” said Krishna Memani, New York-based chief investment officer at OppenheimerFunds, which oversees about $215 billion. “Growth is slower and liquidity is high in the banking system, which bodes well for the bond markets.”

Foreign Outflows

Even so, overseas investors have been dumping bonds as the rally dragged the benchmark 10-year yield to a seven-year low in November. Foreign holdings of Indian government and corporate notes have declined 408 billion rupees ($6 billion) this quarter, the biggest such slide in National Securities Depository Ltd. data compiled by Bloomberg going back to 2011.

The 10-year yield has climbed 23 basis points this month as a panel led by Reserve Bank of India Governor Urjit Patel unexpectedly left interest rates unchanged, and outflows from debt accelerated amid the Federal Reserve’s decision to raise U.S. rates while forecasting a steeper path for borrowing costs in 2017.

Even as economists have slashed India’s growth estimates for the year to March, several of them, including analysts at the Asian Development Bank, forecast expansion to rebound in the following 12 months. While saying that it is retaining an accommodative policy stance, the RBI on Dec. 7 suggested that the cash ban’s impact seemed transitory.

The recent “underperformance of Indian financial markets is probably largely due to the uncertainty surround the demonetization exercise,” said Julian Wee, a Singapore-based senior market strategist at National Australia Bank Ltd. It “will probably reverse when it becomes clearer that the damage from the demonetization will prove to be short-lived.”

HSBC Global Asset Management forecasts the benchmark repurchase rate, which has been lowered six times since the start of 2015 to 6.25 percent, to be cut by 25 basis points in February and another 50 basis points over the next 12 months, according to a report dated Dec. 20.

The Indian rupee’s three-month implied volatility, a gauge of expected swings used to price options, has fallen for a third year, slipping 75 basis points in 2016, data compiled by Bloomberg show.

India “has been a story of interest-rate cuts, and in that respect, we think local bonds are still attractive,” said Sergei Strigo, London-based head of emerging-market debt at Amundi Asset, which oversees over $1 trillion. “It’s possible for Indian bonds to perform further in 2017 -- they have still relatively high carry.”

(Updates foreign-flow data in fifth paragraph.)
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