Investec Snubs Record Indian Bond Sales as HSBC Sees Inflation

June 24 (Bloomberg) -- International investors are balking at Indian Prime Minister Manmohan Singh’s plan to sell a record $74 billion in bonds this fiscal year, saying the country risks a junk debt rating and faster inflation.

Foreign funds cut holdings of local-currency debt by 20 percent from a January peak to $5.7 billion, according to India’s Securities and Exchange Board. Investec Asset Management Ltd., Nikko Asset Management Ltd. and ING Investment Management, which together manage more than $15 billion in emerging-market debt, say they’re avoiding the market.

Yields are rising as Singh boosts spending on infrastructure and programs to reduce poverty, which he says are needed to return the economy to 9 percent growth, from the 6 percent forecast by the central bank for the year started April 1. Standard & Poor’s said June 22 that India may raise its budget deficit estimate in July to 6.5 percent of gross domestic product, the most in 19 years. It has a negative outlook on the nation’s BBB- credit rating, the lowest investment grade.

“Indian bonds are surrounded by deep fundamental risks like the deficit, inflation and the huge supply,” said Peter Eerdmans, who oversees $650 million as the head of emerging- market debt in London at Investec, a Cape Town-based money manager. “There’s no reason for us to have them in our portfolio.”

The global economic recovery depends on the success of Brazil, Russia, India and China, the so-called BRIC nations, Singh said on the eve of a June 16 meeting with his counterparts in the Russian city of Yekaterinburg. He plans to spend $500 billion on infrastructure by 2012 to spur growth and alleviate poverty in a nation where the World Bank estimates three out of four of the 1.2 billion people live on less than $2 a day.

Investec Sells

The nation’s debt delivered losses of 4.2 percent this year, compared with a 0.5 percent decline in China, indexes compiled by HSBC Holdings Plc show. The yield on India’s benchmark 6.25 percent 10-year bond has risen 1.76 percentage points this year to 7.01 percent, even as the government reported the first deflation in three years.

Investec sold its India holdings in late 2008 and will only consider buying if yields increase 1 percentage point because of the risk of inflation, Eerdmans said in a June 18 interview. That would still be below the seven-year high yield of 9.47 percent last July, when inflation was at 12.9 percent.

HSBC, Europe’s biggest bank, predicts wholesale prices will accelerate to as much as 8 percent by the end of March 2010. Prices dropped 1.6 percent in the first week of June, according data compiled by the central bank.

Rate Increase

Bank of America Corp. and Goldman Sachs Group Inc. predict the Reserve Bank of India, which cut key interest rates six times since mid-October, will start raising borrowing costs by early 2010. The overnight lending rate was last reduced in April to a record low of 4.75 percent.

“Investors are bracing for a comeback of inflation,” said Rachana Mehta, the head of debt in Singapore at KE Capital, which is partly owned by Japan’s biggest bank. She predicts the decline in 10-year securities will drive the yield to 8 percent by year-end. Investors would lose 2.7 percent in that scenario, data compiled by Bloomberg show.

While bonds dropped, India’s stocks and rupee rallied after Singh became the nation’s first premier since 1971 to win re- election following a full term. India may sell stakes in state- run companies to foreign investors and inject more capital into lenders to stoke growth, President Pratibha Devisingh Patil said when unveiling Singh’s plans on June 4.

Stronger Growth

The rupee gained 4.5 percent since March 31 to 48.56 per dollar, heading for its best quarter in two years. The Bombay Stock Exchange Sensitive Index, or Sensex, jumped 17 percent the first trading day after election results were announced May 16 and is up 0.3 percent since then to 14,324.01.

Western Asset Management Co., which manages $430 billion, holds more rupee bonds than the index against which it measures its performance, lured by currency gains.

“Stronger growth means higher taxes, higher revenue and lower total government debt,” said Rajeev de Mello, head of Asia debt in Singapore at Western Asset, a part of Baltimore- based Legg Mason Inc.

India’s debt returned 26 percent to dollar-based investors in the past three years, compared with 20 percent for China, 59 percent for Brazil and 18 percent for Russia, according to indexes compiled by JPMorgan Chase & Co.

Fiscal Risk

Finance Minister Pranab Mukherjee will present the new government’s budget proposal on July 6 for the year started April 1. HSBC predicts he will call for increased spending, widening the deficit from the previous year’s 6.2 percent of GDP.

“Fiscal risk in India is among the highest globally,” Takahira Ogawa, a Singapore-based director of sovereign ratings at S&P, said in a June 22 interview. “It will be difficult for the government to address this issue at least for another year.”

India will spend more than 3.7 percent of its economic output servicing debt, compared with 3.6 percent last fiscal year, according to current budget projections.

Sustaining growth for India’s $1.2 trillion economy is a “higher priority at this moment” than sovereign ratings, India’s Finance Secretary Ashok Chawla said at a press conference on May 27. A spokesman in Chawla’s office said this week the finance secretary wouldn’t comment further before the budget announcement. Brazil also has a BBB- credit rating from S&P, Russia’s is a level higher at BBB, while China’s debt is rated A+.

‘Situation Edgy’

“We don’t know how much in debt sales will be enough to get the economy anywhere close to what it was back in 2006 or 2007,” said Gavin Redknap, a strategist in London for Tokyo- based Nikko Asset, which oversees $6 billion in emerging-market debt. “Inflation is going to keep the situation edgy when things turn around.”

He said 10-year yields aren’t attractive below 8 percent.

Foreign funds’ bond holdings, which reached a high of $7.1 billion on Jan. 9, are dwarfed by stock holdings that totaled as much as $60.8 billion on June 12, according to data compiled by the securities board.

Increasing bond sales are damping demand from banks, the biggest buyers. Local lenders’ sovereign debt holdings declined to 25.8 percent of their deposits in May, the lowest in more than a year, reflecting higher savings and fewer debt purchases, central bank data show.

Swings in India’s benchmark bond prices widened to the most on record last month, boosting the potential for losses. A measure of the 10-year yield’s 100-day volatility surged as high as 45 percent in May, Bloomberg data show. The gauge has since dropped to 34 percent, higher than 8.3 percent in Brazil and 26.5 percent in China.

“There’s justifiably some nervousness about the fiscal deficit,” said Shriram Ramanathan, who helps manage $8.7 billion of emerging-market debt in Hong Kong at ING Investment, part of the largest Dutch financial-services group. ING has “exited” all its Indian bond positions, he said.