Hawkish turn by RBI deepens worst India bond rout in 2 decades
February 22 2018 09:37 PM
Reserve Bank of India signage is displayed at the entrance to its headquarters in Mumbai. Expectations for rate hikes are building after minutes of the RBI’s February 6-7 meeting released on Wednesday showed there was concern that inflation already running at faster than 5% will accelerate.


India’s bond rout is deepening as Prime Minister Narendra Modi’s expansionary budget prompts a hawkish turn from the central bank.
Expectations for rate hikes are building after minutes of the Reserve Bank of India’s February 6-7 meeting released Wednesday showed there was concern that inflation already running at faster than 5% will accelerate. Onshore markets are pricing in an increase of about 45 basis points in the benchmark repurchase rate over the next 12 months, said Vivek Rajpal, a rates strategist at Nomura Holdings Inc in Singapore.
India’s public finances are worsening after deficit targets were widened in the budget this month and amid concern over the inflationary impact of rising oil prices and wage hikes for millions of government employees. State-run banks, the biggest holders of sovereign notes, have turned net sellers this year after being hurt by losses. With no local interest and foreigners hemmed in by limits, there doesn’t seem to be any buyers for the debt.
“Indian bonds are seeing capitulation and the pain gets aggravated by every incremental piece of negative news,” said Sandeep Bagla, associate director at Trust Capital Services India Pvt in Mumbai. “Policymakers need to step in to curb the rout and revive investors’ confidence either by allowing more foreign investors or giving assurance on liquidity.” The yield on the nation’s 10-year notes rose seven basis points to 7.78% as of 12:33pm in Mumbai and touched a two-year high, taking this month’s increase to 35 basis points. The debt is headed for a seventh monthly drop, which would be the longest run of declines in data going back two decades.
Inflation accelerated from as low as 1.46% in June to 5.21% in December before easing slightly. The central bank’s goal is to keep headline inflation close to 4% over the medium term.
“Fixed income markets are telling us that we have fallen behind the curve,” Michael Patra, a central banker on the MPC, said at the meeting, according to the minutes. The inflation “target is in danger of getting out of reach” and this could seriously dent the credibility of the committee’s commitment to the target, he said.
As the bond rout deepens, the one group who actually wants to buy the debt looks set to remain shut out of most of the market. The RBI is expected to review the cap on foreign investment in rupee notes, currently set at around 5%, in March or April in the first reassessment since 2015.
For all of the reasons to roll out the welcome mat, regulators may still see the risk of hot-money flows destabilising the rupee as a more potent argument not to. Ashmore Group and UBS Asset Management said they weren’t optimistic the cap would be raised significantly.
“It doesn’t appear they would be too keen to open up the limits very much,” said Ashley Perrott, head of pan Asia fixed income at UBS Asset in Singapore. “It’s that balance between allowing better access, but at the same time wanting to stay in control of the fund-flow picture.”
An RBI spokesman didn’t respond to an e-mailed request for comment on the review.
At the last review in September 2015, the RBI raised the cap from $30bn to 5% of outstanding debt, with the increase gradually phased in through March 2018. Foreign buyers are required to bid for quotas, with the cap preventing the inclusion of the local notes in global indexes.
India also saw its trade deficit widened to the most in four and a half years in January, prompting concern the current-account shortfall will expand. The rupee has fallen 1.8% against the dollar so far this year in the worst performance in Asia after the Philippine peso.
“The limits on foreign participation in the Indian bond market are obsolete,” said Jan Dehn, head of research at Ashmore in London, who said the asset manager would be keen on buying more of the debt if the cap was raised. “The whole of the Indian economy pays for this policy because an open bond market would lower interest rates across the entire yield curve.”
Despite this, Dehn said he wasn’t anticipating authorities would open up the market significantly. “The government is showing increasing tendencies towards protectionism.”

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