Photographer: Dhiraj Singh/Bloomberg

Modi's Bold Bank Fix Carries Risks for Bond Bulls

Updated on
  • Rupee gains in late trade and state-run lenders’ shares soar
  • Nomura stays cautious on 7 to 15-year part of the bond curve

Indian sovereign bonds fell on speculation a government plan to issue special debt to recapitalize state-run lenders will crimp demand for existing notes. Equities rallied to a record and the rupee erased losses in late trade to end higher.

Prime Minister Narendra Modi’s administration will inject an unprecedented 2.11 trillion rupees ($32 billion) into the banks over two years to revive growth. The government will sell 1.35 trillion rupees of recapitalization bonds while banks will raise another 760 billion rupees through “budgetary support” and from the market, according to announcements made late Tuesday.

“Recap bonds will likely not be part of the headline deficit, but they will add to the reduction in bond demand, especially from banks, which are the biggest holders of the securities,” said Vivek Rajpal, a rates strategist at Nomura Holdings Inc. in Singapore. He maintained a cautious stance on the 7-year to 15-year part of the curve.

The S&P BSE Sensex jumped as much as 1.6 percent before closing 1.3 percent higher at a record. State Bank of India, the nation’s largest, surged 28 percent to be the biggest gainer on the gauge. The yield on 6.79 percent notes due May 2027 rose three basis points to 6.81 percent in Mumbai. The National Stock Exchange climbed to a record traded value of 559.1 billion rupees today.

“This big-bang move will break the vicious circle constraining credit and investments to business,” Ajay Bagga, Chairman at OPC Asset Solutions in Mumbai, said by phone. “This decisive and significant move is positive for the overall market as it will boost liquidity in the economy and access to credit for small and medium-sized businesses.”

Read: RBI’s Patel Lauds India Bank Recapitalization Plan

Concern that the government will miss its target to restrict the fiscal deficit to 3.2 percent of gross domestic product in the year to March has been weighing on rupee sovereign bonds. The benchmark 10-year yield is set for a third monthly advance, set for the longest stretch since April 2015.

The rupee gained 0.3 percent to 64.8975 per dollar, erasing an intraday drop of 0.2 percent. The bank funding plan is a short-term negative for the rupee as markets are likely to focus on the potential impact on macro stability as India’s debt-to-GDP ratio rises, Standard Chartered Plc analysts wrote in a report Tuesday. The move is a clear rupee-positive in the long run, they wrote.

India also announced plans Tuesday to spend $108 billion on building highways in the next five years. That, along with the record capital injection, is part of Modi’s latest attempt to revive an economy that’s expanding at the slowest pace in three years.

The measures “mark the opening salvo in the run up to the 2019 general elections and is the first move in transition from PM Modi to Candidate Modi,” Bagga said.

Read: Markets, Moody’s Applaud $32 Billion ‘Bazooka’ for Indian Banks

The recapitalisation bonds will not be included in the central government’s budget, according to Australia and New Zealand Banking Group Ltd. Such notes in Indonesia and Thailand were kept outside of the budget during the Asian financial crisis in the late 1990s, Sanjay Mathur, chief economist for Southeast Asia and India at ANZ, wrote in a report.

— With assistance by Netty Idayu Ismail

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