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India’s Truce With Bond Traders Tested as Borrowing Jumps

Subhadip Sircar and Anirban Nag
·4-min read

(Bloomberg) -- The Reserve Bank of India’s week-long truce with the bond market will be tested in coming days after Prime Minister Narendra Modi’s government ramped up borrowing, barely two weeks after keeping it unchanged.

Federal authorities will raise an extra 1.1 trillion rupees ($15 billion) on behalf of the states to help with a shortfall in tax revenue, the finance ministry said late Thursday. This will be done via sales of three- and five-year bonds, according to the central bank.

Yields rose on Friday, before a pre-scheduled debt auction. The sale however was the second in as many weeks to go through without help from underwriters, after Governor Shaktikanta Das doubled the size of open-market bond purchases and asked traders to consider their “shared responsibility” for maintaining a stable market.

The moral suasion and promise of more buying had pushed the benchmark 10-year rate a comfortable 10 basis points below 6% before Thursday’s surprise increase in borrowing. This is a level traders see the RBI trying to defend, but the job will become difficult with more bonds coming to market amid a spike in consumer prices.

The rate rose 4 basis points to 5.94% on Friday, while the five-year yield jumped 10 basis points to 5.26% and the four-year bond yield was up 10 basis points.

“Fiscal slippage or stickier-than-projected inflation further down the road could once again incite challenges,” Vishnu Varathan, head of economics and strategy at Mizuho Bank Ltd. in Singapore, said before the news on Thursday. “Expectations for significant pullback in yields may be disappointed.”

Last week’s debt auction also went off smoothly after Das ratcheted up his rhetoric and boosted the size of individual open-market bond purchases to 200 billion rupees. Traders had balked at the low yields on offer before that, forcing underwriters to rescue four of the previous seven sales.

India’s Playbook

The RBI’s approach to managing yields stands in stark contrast to the clearly defined bond-buying policies of its peers in much of Asia and around the world, leaving investors with more uncertainty.

It doesn’t have an explicit yield target like the Bank of Japan, or a quantitative purchase goal like the Reserve Bank of New Zealand. Nor does it have a set calendar for purchases like the Bank of Korea.

Instead it has tried to ensure markets have ample liquidity, while relying on ad hoc “twist” operations -- simultaneous purchases and sales of bonds of different maturities -- along with discreet purchases and outright OMOs. It has announced its first purchase of state debt of 100 billion rupees for Oct. 22.

Also setting the RBI apart is its struggle to lower inflation at a time when many other central banks are battling to rekindle price gains.

After seeing price gains significantly overshoot its targeted 2%-6% range, the central bank is now telling investors they can look through the latest bout of inflation.

While consumer price gains rose to an eight-month high of 7.34% in September from a year earlier, they will ease to 5.4% in last three months of this year, and drop to 4.5% in the following quarter, the RBI said last week.

Inflation Risk

“But what happens if it doesn’t?” said Rajeswari Sengupta, assistant professor at Indira Gandhi Institute of Development Research in Mumbai. “Would it just allow inflation to continue, without taking action to bring it down to acceptable levels? This wasn’t clear from the statement. Either way, the RBI’s credibility would be severely dented.”

Indian consumers appear even more concerned that high prices will persist, with the median inflation expectation of households over a one-year period sitting at 10.3%.

Rating companies however said they had already factored in the increase in borrowing and it wouldn’t affect their assessments. S&P Global Ratings and Fitch Ratings forecast India’s combined deficit -- federal and state governments -- will widen to about 12% of GDP in the year through March.

Worries over a spending blowout show up in the wide gap between the central bank’s short-term repurchase rate and 10-year yields.

“The Das put will keep getting tested and the market will now look forward to weekly OMOs of 200 billion rupees if the 10-year bond yields have to remain below 6%,” said Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt Ltd. in Mumbai.

(Updates with auction results, rating company comments)

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