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Merrill Lynch, Franklin look to govt debt as interest rates peak

Merrill Lynch, Franklin look to govt debt as interest rates peak
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First Published: Mon, May 07 2007. 11 07 PM IST
Updated: Mon, May 07 2007. 11 07 PM IST
By Sam Nagarajan and Anil Varma/Bloomberg
Mumbai: Merrill Lynch and Franklin Resources Inc. are increasing purchases of Indian government debt, predicting that the central bank will end two-and-a-half years of interest rate increases.
DSP Merrill Lynch Fund Managers Ltd, a unit of New York-based Merrill, last week raised Rs280 crore for its first Indian bond fund since 2002. Franklin Templeton India, part of the San Mateo, California-based money manager, doubled holdings of benchmark debt in one of its funds in March.
“India is now closer to a peak in interest rates,” said Dhawal Dalal, who manages the equivalent of $1.3 billion (Rs5,330 crore) of debt at DSP Merrill in Mumbai. “The time is probably right for investors to start considering bond funds,” he added.
The increase in demand for the securities may bolster prices for Indian bonds, which have slumped since 2004. Bond investors’ returns have been eroded after faster growth caused inflation to accelerate and pushed yields on government debt to the third-highest in Asia.
The yield on the benchmark 8.07% note due January 2017 rose 17 basis points, or 0.17 percentage points, in April, to 8.17%, close to a four-and-a-half year high of 8.4%. Only Pakistan and Indonesia have higher 10-year yields in Asia. The price fell Rs1.1 per Rs100 face amount to 99.32.
The yield will drop to 7.5% by year-end, said K. Ramkumar, who manages the equivalent of $1.3 billion in debt at SBI Funds Management Pvt. Ltd in Mumbai. That would give investors a 9.7% return.
“2007 is the year of debt,” said Ramkumar. “There will be one more monetary tightening measure.” SBI Funds is part of State Bank of India, the nation’s biggest lender by assets.
Prime Minister Manmohan Singh’s economic policies have helped boost growth in Asia’s fourth-largest economy for three years, prompting India’s benchmark Sensex stock index to almost triple and driving borrowing costs higher.
Indian bonds were the worst performers among 10 Asian local-currency bond markets outside of Japan during this period, according to London-based HSBC Holdings Plc. They have returned 3.07% in the three years ended 27 April. with Hong Kong debt following with returns of 8.8%.
Growth in India, which trails only China among the world’s 20 biggest economies, may slow to 8.5% in the year ending 31 March 2008 after expanding 9.2% last year, according to the Reserve Bank of India (RBI).
The central bank, led by governor Y.V. Reddy, kept the overnight lending rate unchanged at 7.75% on 24 April 24. RBI has raised its benchmark rate nine times since October 2004. Only four of 11 economists in a Bloomberg survey see a higher repurchase rate by RBI’s 31 July meeting.
The yield on 10-year bonds compared with one-year government debt narrowed to 22 basis points from 121 basis points a year ago, according to Bloomberg data. That suggests investors are anticipating slower inflation and a pause in rate increases.
“The central bank is done hiking interest rates,” said Vikas Agarwal, a strategist at New York-based JPMorgan Chase & Co. in Mumbai. “We may be coming close to the stage where we could see an asset allocation shift. Timing will be the issue,” he added.
Agarwal says 10-year yields may fall to 7% in a year.
Banks, which own 75% of outstanding debt, have been selling to raise cash. The central bank has raised the reserve ratio for lenders by 1.5 percentage points since December to 6.5% of deposits.
“As long as the worry on inflation remains, and the expectation of tight liquidity prevails, there isn’t much juice in bonds,” said K. Ramanathan, who manages the equivalent of $900 million in Indian debt at ING Investment Management (India) Pvt. Ltd in Mumbai. It is part of Amsterdam-based ING Groep NV, the largest Dutch financial services firm.
Franklin Templeton India, which manages the equivalent of $6 billion, doubled holdings of the benchmark 10-year note in its Templeton India Government Securities Fund composite plan to Rs450 crore in March, according to regulatory filings.
Bond yields could start to drop as long as oil prices remain stable, said Santosh Kamath, chief investment officer (fixed income) in Mumbai, declining to confirm the purchases.
Asset managers outside India, whose ownership is limited to less than 2% of the $250 billion market, are also buying. Overseas funds bought $562 million more in debt than they sold in the past two months, after net sales of $750 million in January and February, according to exchange data.
The rupee’s 8.3% gain this year will also reduce the cost of imports and contain inflation, said Poonam Tandon, a trader at Development Credit Bank Ltd, a 70-year-old lender based in Mumbai. “The worst may be over for bonds,” Tandon said.
Oliver Biggadike in Tokyo and Wes Goodman in Singapore contributed to this story
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First Published: Mon, May 07 2007. 11 07 PM IST
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