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The rally in Indian sovereign bonds has met a surprising foe: inflation in the midst of the nation’s worst slowdown in more than four decades.
A surge in consumer prices, and expectations that it could exceed 10 per cent in three months, is raising the spectre that the Reserve Bank of India’s easing cycle is nearing its end months after it cut rates to revive a virus-ravaged economy.
That has become an all-consuming topic among Mumbai traders, who were nervously looking over their shoulders even when bond yields were near a decade-low earlier this month. With two poor consecutive debt auctions, the looming risk of stagflation raises questions over Prime Minister Narendra Modi’s plan to borrow a record ₹12-lakh crore ($160 billion).
“The outlook is one of worry about inflation combined with hopes of bond purchases by the RBI,” said Harihar Krishnamoorthy, treasurer at FirstRand Bank in Mumbai. “Inflation in the short term is likely to remain sticky and elevated, leaving little room for the RBI to cut rates till the year-end.”
Yields on the benchmark 10-year debt have risen 38 basis points to 6.15 per cent in the past four weeks.
Flagging demand has plagued two straight auctions. Underwriters were forced to rescue the sale of a 10-year debt on August 14, while a week later an auction of longer-tenor notes saw higher-than-expected cut-off yields.
Another auction is due Friday.
On Tuesday, the central bank said it will resume its Federal Reserve-style Operation Twist to cool yields. While the RBI has refrained from debt monetisation like in Indonesia, it has cut rates by 115 basis points this year, conducted discreet secondary market purchases and done three Twists of ₹10,000 crore each since April 1.
“The limited Twists provide a temporary relief,” said Naveen Singh, head of fixed-income trading at ICICI Securities Primary Dealership in Mumbai. “The RBI needs to express a clear commitment of support. Absent that, the market may find demand-supply equilibrium at around 7 per cent for the benchmark bond yield.”
Growing discomfort
Wagers on further easing waned after July inflation spiked to near 7 per cent. On top that, the RBI’s forward-looking survey points to CPI quickening to 10.5 per cent in three months.
The central bank’s growing discomfort with the trajectory was voiced by its Deputy Governor Michael Patra in the latest minutes. The RBI will be forced to take an immediate and more than proportionate response to quell price pressures if inflation stays above the tolerance limit of 6 per cent for another quarter, he said.
“The RBI doesn’t manage yield levels, which are impacted by many other factors including global developments,” Governor Shaktikanta Das said at an event in Mumbai on Thursday.
DSP Investment Managers expects 10-year yields to reach 6.25 per cent amid uncertainties on the frequency of new twist operations.
“We will see pain expanding at every weekly bond auction if the central bank doesn’t extend its support,” said Saurabh Bhatia, head of fixed income at the Mumbai-based money manager.
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