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Raghuram Rajan powerless to back Modi amid inflation risk

The yield on benchmark one-year sovereign notes has exceeded that on 10-year securities in the past five weeks, data compiled by ‘Bloomberg’ show, indicating investors expect no let-up in inflation over the next 12 months. Photo: Abhijit Bhatlekar/MintPremium
The yield on benchmark one-year sovereign notes has exceeded that on 10-year securities in the past five weeks, data compiled by ‘Bloomberg’ show, indicating investors expect no let-up in inflation over the next 12 months. Photo: Abhijit Bhatlekar/Mint

Bond market is signalling that the RBI governor has no room to support Prime Minister's growth push by cutting rates

Mumbai: India’s bond market is signalling central bank governor Raghuram Rajan has no room to support Prime Minister Narendra Modi’s growth push by cutting interest rates.

The yield on benchmark one-year sovereign notes has exceeded that on 10-year securities in the past five weeks, data compiled by Bloomberg show, indicating investors expect no let-up in inflation over the next 12 months. Indian debt maturing in a year yields 20 basis points more than that due in a decade. In China, the shorter debt yields 45 basis points less.

Modi, elected in a landslide win in May, needs to boost investment to aid the economy’s recovery from close to the slowest growth in a decade. Nomura Holdings Inc. and Citigroup Inc. predict Rajan will have to keep the benchmark rate at 8% though the end of 2015 to bring inflation below 6%. The median estimate in a Bloomberg survey is for no cut in the next nine months.

“Rajan is pursuing a 6% inflation target and hence won’t be able to support Modi with lower policy rates until that goal is clearly visible," Vivek Rajpal, a Singapore-based rates strategist at Nomura, said in an interview on Tuesday. The Reserve Bank of India (RBI) is on hold for the foreseeable future, which effectively means one-year rates will remain high.

Inflation target

Consumer prices rose 7.96% in July from a year earlier compared with a 7.46% increase in June, when it slipped below 8% for the first time since January 2012, official data show.

Rajan aims to bring the rate to 8% by January and 6% a year later. He kept RBI’s repurchase rate unchanged on 5 August and indicated risks to his 2016 inflation target. The governor also flagged risks from the government’s price support for crops, a deficient monsoon and oil costs amid geopolitical conflicts.

The yield on 10-year benchmark government bonds has declined 23 basis points, or 0.23 percentage point, since 30 June to 8.52% on Tuesday, while that on one-year notes has climbed 32 basis points to 8.72%, data compiled by Bloomberg show. The rupee weakened 0.8% this quarter to 60.68 per dollar, paring its 2014 advance to about 2%.

“Inflation will be sticky at current levels in the short term, and that’s getting reflected in the short end of the yield curve," Debendra Kumar Dash, a fixed-income trader at DCB Bank Ltd in Mumbai, said in a 1 September phone interview. “There’s expectation that if you hold the long bond, you’ll get some profit as the long-term inflation outlook is benign."

Faster growth

Gross domestic product (GDP) expanded 5.7% from a year earlier in the April to June period, an official report showed on 29 August, the most since the first quarter of 2012. Faster growth may add to price pressures and keep RBI from cutting rates, according to Dash.

The central bank predicts expansion in Asia’s third-largest economy will accelerate to 5.5% in the fiscal year ending March 2015 from 4.7% in the previous 12 months. Growth slumped to 4.5% in the year ended March 2013, the least since 2003.

“Any rise in consumption or investment demand will once again fuel inflationary pressures," Indranil Pan, an economist in Mumbai at Kotak Mahindra Bank, said in a 1 September email interview. “In this context, it is likely that monetary policy will remain restrictive and could hurt prospects for growth."

Rajan, a former International Monetary Fund (IMF) chief economist, raised interest rates three times since he took office a year ago, with the last increase coming in January.

Rate forecasts

While most economists surveyed by Bloomberg from 22 August to 27 August see no change in the benchmark rate through June, a few predict it will rise rather than fall as Rajan seeks to rein in inflation. A few forecast reductions.

Goldman Sachs Group Inc. forecasts a 50 basis points increase to 8.5% in the next six months, while JPMorgan Chase and Co. and HSBC Holdings Plc predict a 25 basis points rise in the next three months, according to a Bloomberg News survey.

Barclays Plc estimates inflation will average between 7% and 7.5% in the year through March, lower than the central bank’s January 2015 goal, which will allow the monetary authority to cut rates by 50 basis points by the end of this year. Bank of America Corp.’s Merrill Lynch unit predicts a 75 basis points reduction by June.

The cost of locking in borrowing costs for a year climbed 8 basis points to 8.46% in August, the biggest jump since January, data compiled by Bloomberg show. The rate, which slid to an 11-month low of 8.16% in June in anticipation of monetary easing, was little changed on Tuesday.

“RBI is likely to stay on pause over the next 12 months," Prasanna Ananthasubramanian, chief economist at ICICI Securities Primary Dealership in Mumbai, wrote in a 1 September research note. “We expect the RBI to keep real policy rates firmly in positive territory to foster macrostability at a time when murmurs of US monetary policy normalization are growing louder." Bloomberg

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