India bond party set to cool amid inflation, fiscal risks

THE BULL RUN in Indian sovereign bonds is petering out as accelerating inflation and the risk of worsening public finances cloud the outlook for Asia’s highest-yielding securities.

The benchmark 10-year yield, up 24 basis points in 2017, may climb further as rising living costs prevent the Reserve Bank of India (RBI) from cutting interest rates, according to HSBC Holdings Plc and Emkay Global Financial Services Ltd. A potential increase in government borrowing, which will boost debt supply, also threatens to depress bond prices, after the yield sank 231 basis points in the last three years.

“The outlook for bonds is negative,” said Manish Wadhawan, head of interest-rate trading at HSBC Holdings in Mumbai. That’s because the “RBI is likely to be on a pause till December” and it is selling bonds via the open market at a time when banking-system liquidity is declining, he said. “Likely widening of the fiscal deficit is also a huge risk.”

The 10-year yield was steady RBI’s move has seen bonds extend declines in October after posting their first back-to-back monthly losses since 2015. The sell-off in one of region’s most sought-after investment destinations has been amplified by government comments that it was considering measures to boost economic growth, which slowed to a three-year low last quarter.

That’s even as the fiscal deficit for April to August has already reached 96.1% of the full-year target. The administration isn’t ruling out additional debt sales, Economic Affairs Secretary S.C. Garg said last month.

Given that fiscal slippage looks “fait accompli,” and the RBI is on a prolonged pause, “the outlook for the bond market looks dire,” said Prasanna Ananthasubramanian, Mumbai-based chief economist at ICICI Securities Primary Dealership Ltd. He sees the 10-year yield ranging between 6.65% and 6.85% in the next two months.

While local investors are pessimistic, their overseas peers such as Aberdeen Standard Investments and Pacific Investment Management Co. are viewing the sell-off as a fresh reason to add to their bond positions in what’s still one of the world’s fastest-growing major economies.

“India is still one of the standout markets over a three-to-five-year time horizon,” said Adam McCabe, head of Asian fixed income at Aberdeen Standard. “It’s still a reasonably high carry market. The recent sell-off has been driven by concerns about fiscal slippage. It’s not a key longer term concern.”

DRAINING LIQUIDITY
However, the restrictions on overseas investment in debt mean that foreigners — who have almost exhausted their bond-buying limit — have little sway over the market. Local state-run banks are the biggest holders of sovereign debt.

Demand for bonds is likely to cool also due to central bank intervention to absorb the liquidity that was pumped into the banking system following the government’s shock currency ban in November, according to HSBC’s Wadhawan. He sees the yield in a range of 6.65% to 6.80% up to Dec. 31, up from a previously estimated band of 6.45% to 6.65%.

“The best phase of the bond market may be behind us,” said Dhananjay Sinha, head of institutional research at Emkay Global in Mumbai. Sentiment is turning “more and more bearish given that the RBI is likely to sound less neutral going ahead,” he said. — Bloomberg