Worst performer among Bric, Indian bonds to extend drop on spiralling fuel prices

Written by Bloomberg | Updated: May 19 2011, 07:19am hrs
Indian bonds, the worst performers among Bric nations, may extend declines as the biggest increase in gasoline prices in three years threatens to accelerate inflation, banks and primary dealers say.

Yields on 10-year government debt will rise 10 basis points, or 0.10 percentage point, by June 30 to 8.40%, the highest level since October 2008, according to the median estimate of nine analysts in a survey. Morgan Stanley India Primary Dealer, a unit of the worlds largest brokerage, predicted 8.75%. The benchmark 10-year bond rate climbed 36 basis points this year in India and 30 basis points in Brazil, while falling 6 bps and 5 bps respectively in China and Russia.

India may decide on raising diesel prices soon, after increasing the cost of gasoline by about 9%, cabinet secretary KM Chandrasekhar said on May 12. The Reserve Bank of India has raised interest rates nine times since March 2010 to stem inflation.

Indian bonds will lead the inflation trajectory and we do not recommend buying them until there are clear signs of inflation moderating, Vivek Rajpal, Mumbai-based fixed-income strategist, Nomura Holdings, said on May 16. Any moderation in inflation is unlikely as the hike in fuel prices will keep prices elevated.

Nomura, Japans largest brokerage, forecasts 10-year yields will reach 8.45% this quarter.

Local-currency bonds returned 0.7% this year, trailing gains of 6.5% in Brazil, 1.5% in China and 3.5% in Russia, a JPMorgan Chase & Co index shows. Rupee bonds are Asias worst performers this month after the Philippines, losing 0.3%, according to indexes compiled by HSBC Holdings.

The yield on the most-traded 7.8% note due in April 2021 added two basis points from May 16 to 8.30%, approaching a 31-month high, as the commerce ministry said wholesale prices rose 8.66% in April from a year earlier, exceeding the median forecast of 19 economists in a survey for 8.5%.

Indian Oil Corp raised gasoline prices by R5 a litre to R63.37 ($1.4) in New Delhi on May 15, the biggest increase since June 2008. Crude oil has climbed 41% in New York in the past year.

Increases in fuel and cooking gas prices will add one percentage point to inflation, Indranil Pan, chief economist, Kotak Mahindra Bank in Mumbai said on Tuesday. Inflation is unlikely to be comforting this year, which will put upward pressure on bond yields, Pan said.

Reserve Bank governor Duvvuri Subbarao raised the benchmark repurchase rate by half a percentage point to 7.25% on May 3, the biggest increase in three years.

We pencil in a cumulative rate hike of 50 basis points by July by the central bank, Mumbai-based Siddhartha Sanyal and Singapore-based Kumar Rachapudi, analysts at Barclays, wrote in a note to clients on May 16. This will likely keep bond yields biased higher in the near term and will likely drag swap rates higher as well.

The cost of fixing debt payments for a year using interest- rate swaps rose to 8.14% on May 11, the highest level since October 2008. Investors use the derivative contracts to guard against rate fluctuations.

Credit default swaps tied to government-owned State Bank of India, which some investors perceive as a proxy for the nation, increased 10 basis points to 175 basis points this month, according to data compiled by CMA, which is owned by CME Group and compiles prices quoted by dealers in the privately negotiated market. The contracts insure debt against non- payment, and traders use them to speculate on credit quality.

State Bank of India plunged in Mumbai trading on Tuesday after fourth-quarter profit dropped 99% to the lowest in at least 10 years as it set aside more funds for bad loans. Chairman Pratip Chaudhuri, who took the helm at the state-owned company last month, said lending this year may be restricted because of higher interest rates.

HSBC and Credit Suisse Group raised their estimates for increases in the central banks benchmark rate this month. The UK bank that gets more than half of its profit from Asia now expects Subbarao to raise the rate to 8% by December 31, compared with an earlier estimate of 7.5%, while Credit Suisse predicts a 75 basis-point rise by September.

The increase in fuel prices may help the government move toward achieving its aim to cut the budget deficit to a four- year low of 4.6% of gross domestic product, Rupa Rege Nitsure, economist, state-owned Bank of Baroda, said.

It is important to keep the budget deficit under check otherwise it will undermine RBIs fight against inflation, Mumbai-based Nitsure said.

While faster inflation is eroding returns for domestic debt investors, increasing relative yields are making Indian bonds more attractive to overseas buyers.

The difference in yields between the nations government debt and US Treasuries due in a decade has widened to 513 basis points from a nine-month low of 436 reached April 8.