India’s 10-year bonds rose, ending a two-day decline, on speculation that slowing inflation will allow the central bank to stop raising interest rates.
Yields, which move inversely to prices, dropped from the highest in two weeks after a government report on 11 May showed the inflation rate eased to the lowest in almost five months. The Reserve Bank of India (RBI) has raised borrowing costs nine times since October 2004 to temper inflation.
“The outlook is positive for bonds because the headline inflation number is declining,” said Mahendra Jajoo, who manages the equivalent of $1.2 billion (Rs4,920 crore) of Indian debt at ABN Amro Asset Management Ltd in Mumbai. “The central bank may refrain from raising interest rates further as inflation slows, and maintain a wait-and-watch policy stance.”
The yield on the benchmark 8.07% note, due January 2017, fell two basis points, or 0.02 percentage point, to 8.15% as of the 5:30pm close in Mumbai, according to RBI’s trading system. The price rose 0.12, or 12 paise per Rs100 face value, to 99.44. The 10-year yield may drop as much as 25 basis points in the next month, Jajoo said.
India’s inflation rate slowed to 5.66% in the week ended 28 April, from 5.77% the previous week, the ministry of commerce and industry said in a statement on 11 May. Economists forecast a rate at 5.75% according to a Bloomberg News survey.
The Reserve Bank expects inflation to slow to 5% by the end of the financial year on 31 March, after it increased borrowing costs to damp consumer demand. The central bank may be approaching the end of its policy of raising rates, nine of 11 analysts in a Bloomberg survey said last month. Bonds pared gains on concern investors will demand higher yields after the government auctioned debt at rates above forecasts on 11 May.
“The yield cut-off at the auction was high, suggesting the central bank isn’t comfortable about letting yields fall yet,” said Krishnamurthy Harihar, treasurer at Development Credit Bank Ltd in Mumbai. “Bond yields will remain high for some time.”
The Union government auctioned Rs6,000 crore of 10-year debt at a yield of 8.31% on 11 May, compared with the 8.25% median forecast by traders in a Bloomberg survey. It also sold Rs4,000 crore of 29-year bonds at a yield of 8.64%.
Bonds also advanced on speculation banks will increase their holdings of debt, as required by law, in line with their rising deposits.
Indian lenders must invest at least 25% of deposits in debt. Bank deposits rose 22% in the year ended 27 April, beating a 20% gain the previous year.
“Banks’ demand for debt to meet reserves will remain a support for bonds in the coming weeks,” Jajoo said.
The cost of India’s interest-rate swaps, derivative contracts used to guard against the risk of an increase in borrowing costs, rose on speculation demand for the instruments will increase to reflect higher borrowing costs in the money market. The five-year swap rate climbed two basis points to 8.14.
Overnight rates in the money market rose to 8.88% on Monday from 2.5% on 11 May on speculation payments for debt sold by the government and RBI will drain the spare cash at banks.