Inflation Spike Brings India Bond Rally Shuddering to a Halt
A vegetable vendor works in his stall in a market in Mumbai, India, on Friday, Jan. 4, 2008. India’s inflation held below the central bank’s target for a sixth month. (Photographer: Prashanth Vishwanathan/Bloomberg News)

Inflation Spike Brings India Bond Rally Shuddering to a Halt

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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% in three months, is raising the specter 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 three poor consecutive debt auctions, the looming risk of stagflation raises questions over Prime Minister Narendra Modi’s plan to borrow a record 12 trillion rupees ($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 Ltd. 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.”

Inflation Spike Brings India Bond Rally Shuddering to a Halt

Flagging demand has plagued recent auctions. Underwriters were forced to rescue the sale of a 10-year debt for the second time in three weeks on Friday and bought most of the 180 billion rupees of the government stock on sale.

Still, benchmark yields declined by as much as 10 basis points after the government sold benchmark paper at lower-than-expected cutoff yields in a signal that the RBI wants to cap the surge in yields, which have risen more than 30 basis points in the past four weeks.

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 monetization like in Indonesia, it has cut rates by 115 basis points this year, conducted discreet secondary market purchases and done three Twists of 100 billion rupees 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%” for the benchmark bond yield, he said.

Inflation Spike Brings India Bond Rally Shuddering to a Halt

Wagers on further easing waned after July inflation spiked to near 7%. On top that, RBI’s forward-looking survey points to CPI quickening to 10.5% 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% 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 Pvt. expects 10-year yields to reach 6.25% 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 Mumbai-based money manager.

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