Patel May Hold Bond Quotas as India Faces Impossible Trinity
(Bloomberg) -- Foreigners looking to buy Asia’s best bonds will probably have to wait.
Reserve Bank of India’s Governor Urjit Patel is unlikely to raise the quota on debt after inflows surged and muddied policy choices. He can’t allow runaway currency gains because exports are only just recovering from a slump, so he’s buying up the dollars pouring in. This injects rupees into a bloated banking system, complicating efforts to reduce liquidity. At the same time, slowing growth pushed him to cut the policy rate this month.
“All the monetary policy objectives in this case actually militate against each other," said Soumya Kanti Ghosh, chief economic adviser at State Bank of India, the country’s biggest lender and one of its top foreign currency traders. "The central bank right now has to work a very delicate balance" and "may be a little wary of increasing the foreign investor limits."
India is facing the ‘impossible trinity,’ an economic concept which argues that it isn’t possible to simultaneously pursue free movement of capital, a fixed-exchange rate and an independent monetary policy. Something’s got to give, and since the RBI has an inflation mandate and needs to control the rupee, it will clamp down on capital flows.
Global funds have bought more than 99 percent of all the Indian sovereign and corporate bonds they’re allowed to buy. While policy makers have a road map to raise the cap on government debt each quarter, there’s no such plan for corporate bonds. The prospect of a return to world-beating economic growth following a tax overhaul by Prime Minister Narendra Modi is also attracting equity investors.
Investors earned 15 percent on rupee sovereign notes in 2016, the most in Asia.
The rupee has advanced about 6.3 percent this year on the back of $30 billion inflows into debt and stocks, despite the central bank intervening to purchase dollars in the spot and forward market. It hit a two-year high this month and gained 0.2 percent to 63.9150 per dollar on Monday. The central bank has maintained that it intervenes only to curb volatility and doesn’t target any particular level for the rupee.
“One of the other factors which has contributed to the rupee’s strength is the nature of the monetary policy framework,” said Ananth Narayan, Mumbai-based regional head of ASEAN & South Asia financial markets at Standard Chartered Plc. An independent monetary policy centered on inflation means that interest-rate differentials favor the rupee. “In the current context, there is little direct incentive for Indian authorities to ease foreign portfolio investment limits into debt further.”
Overseas investors raised holdings of rupee-denominated government and corporate bonds by almost 1.5 trillion rupees ($23.5 billion) this year through August 24. They’re set for seven straight months of purchases, the longest streak since April 2015, lured by Asia’s highest inflation-adjusted rates.
One way to stem the inflows is if the central bank lowers the policy rate again following this month’s cut, as expected by a few analysts in a Bloomberg survey. That action would be in line with the downside risks to growth flagged by Patel in the minutes of the latest meeting.
However, most analysts predict he’ll keep rates on hold through 2018 as price pressures rebounds from a record low of 1.46 percent in June. The Reserve Bank of India forecasts inflation will rise toward its 4 percent medium-term target by March 2018.
“In the context of managing this trilemma challenge, investors have asked if the RBI will cut policy rates and lower real rates to prevent further currency appreciation," Morgan Stanley analysts led by Derrick Kam wrote in a August 16 note. "But we think this is unlikely as the RBI is following a flexible inflation targeting regime.”