India's Budget Puts Central Bank in a Bind as Market Eyes Rate HikeBy and
RBI juggling twin roles of debt manager, inflation targeter
No change expected this week; swaps pricing in 2018 tightening
The Reserve Bank of India’s job as the government’s debt manager just got harder after the federal budget unveiled a near-record $95 billion borrowing plan in the coming fiscal year.
Governor Urjit Patel needs to keep interest rates low to ensure Prime Minister Narendra Modi can bridge a widening fiscal deficit. But he also needs to bring down an inflation rate that breached the 4 percent midpoint of the target band late last year, and which is expected to climb as the government increases spending before a general election next year.
That draws a line under the RBI’s policy easing cycle, with all but one of the 33 economists in a Bloomberg survey predicting the benchmark repurchase rate will remain unchanged at 6 percent on Wednesday. Swap markets are pricing in some tightening in 2018, which risks driving investors away from what is already Asia’s worst performing bond market.
“The next financial year will no doubt pose a challenge not just for the RBI but also all the market participants,” said Indranil Pan, chief economist at IDFC Bank Ltd. “The RBI will have to accept higher yields at the auctions as the macro-economic situation and the global situation warrants one.”
Unlike most major economies where an independent debt office handles the government’s borrowing program, in India the onus is on the central bank. Its primary objective though is keeping a lid on inflation and juggling both roles is proving a dilemma for policy makers as price pressures pick up.
Consumer prices rose 5.2 percent in December from a year earlier, and a Bloomberg survey shows the inflation rate is expected to hit 5.5 percent by June. This -- together with a surge in global yields -- is deepening the RBI’s conflict and signs of trouble are already emerging.
The RBI has struggled to sell bonds at multiple auctions this year as the rapid drop in bond prices drove investors away, especially state-run banks which are the biggest buyers. Bonds declined for six straight months through January, the longest stretch since 2000, and the slump has continued into February.
Higher yields amid relatively tighter cash conditions for banks could undermine a nascent recovery in lending and investment in Asia’s third-largest economy.
What Our Economists Say...Higher borrowing costs damp growth and add strain to weak balance sheets of public-sector banks -- reasons not to tighten. The RBI may justify its previous hawkish stance on Wednesday but is likely stay in wait-and-see mode.
-- Abhishek Gupta of Bloomberg Economics
Also, lenders can’t assume the RBI will step in to help this time around. The deputy governor in charge of monetary policy, Viral Acharya, last month warned banks that they will have to manage the impact of rising yields on their balance sheet and not seek the regulator’s help.
“The regulator, in interest of financial stability, is caught in such situations between a rock and a hard place, and often obliges,” he told bond traders. “However, the trend of regular use of ex-post regulatory dispensation to ease the interest-rate risk of banks is not desirable from the point of view of efficient price discovery.”
For bond investors, the outlook is gloomy amid a pick up in borrowing and inflation.
“There is a crisis of confidence right now,” said Mahendra Jajoo, who oversees 20 billion rupees ($312 million) in assets as head of fixed income at Mirae Asset Global Investments (India) Pvt. “Some signs of stability has to return for sentiment to turn.”
— With assistance by Manish Modi, and Ruth Pollard