`Dramatic' Inflation Change Increases Bets on Interest Rates: India Credit

Local banks in India are joining Goldman Sachs Group Inc. in predicting benchmark borrowing costs will climb 1 percentage point in 2011 before a report this week forecast to show inflation accelerated for the first time in three months in December.

Wholesale prices, the benchmark gauge, gained 8.40 percent from a year earlier, faster than the 7.48 percent rate in November, according to the median forecast of 29 economists in a Bloomberg survey before data due on Jan. 14. Axis Bank Ltd., the nation’s fourth-biggest lender by market value, raised its forecast from 75 basis points yesterday. Mumbai-based Yes Bank Ltd. made the same adjustment last week.

One-year interest-rate swaps in India have climbed 34 basis points, or 0.34 percentage point, in the past month, the most among the so-called BRIC economies of the largest developing nations, reflecting expectations that the Reserve Bank of India will raise rates as soon as this month. Prime Minister Manmohan Singh is under pressure to curb inflation as his Congress party faces elections in nine states over the next 18 months.

“The dramatic change in the inflation trajectory prompted us to revise our call to a more hawkish one,” Shubhada Rao, a Mumbai-based economist at Yes Bank, said in an interview yesterday. “Inflation is like a ubiquitous tax, and the government will be under pressure to get inflation under control as early as possible.”

Food Prices

Food prices surged 18.3 percent in the week ended Dec. 25, the most since July, according to a Commerce Ministry report issued on Jan. 6. The annual wholesale inflation rate, which climbed as high as 11 percent in April, fell in both October and November.

The central bank will review borrowing costs next on Jan. 25 after raising the benchmark repurchase rate six times last year.

Any increase in food costs “feeds into the rest of the sectors in the economy,” Chakravarthy Rangarajan, the prime minister’s top economic adviser, said in an interview on Jan. 7. If prices remain “sticky, probably some action will be required,” said Rangarajan, who led the Reserve Bank between 1992 and 1997.

Tushar Poddar, a Mumbai-based economist at Goldman Sachs who correctly predicted that the central bank would raise the benchmark repurchase rate by 150 basis points in 2010, said in an interview yesterday that the biggest risk to inflation is higher food and commodity prices. Poddar told reporters in Mumbai on Dec. 8 that he expects the central bank to lift interest rates 100 basis points in 2011.

The yield on India’s 10-year bonds has risen 33 basis points this year. The rate on the most-traded 7.8 percent security due in May 2020 climbed 2 basis points to 8.22 percent yesterday.

Swap Rates

“With inflationary pressures persisting, we expect yields to remain elevated for a prolonged period,” Anubhuti Sahay, an economist at Standard Chartered Plc in Mumbai, said in an interview yesterday. She predicts the 10-year rate will rise to 8.50 percent by the end of the current financial year in March.

The difference between India’s 10-year bonds and U.S. Treasuries widened to 493 basis points yesterday from 463 at the end of last year.

India’s one-year swap rate, the fixed cost needed to receive a floating interest rate, climbed to 7.30 percent from 6.96 percent on Dec. 10. Comparable rates in Brazil have gained 11 basis points to 12.12 percent, those in Russia have climbed 22 basis points to 5.25 percent and those in China have increased 2.5 basis points to 3.17 percent.

India’s government bonds have lost 0.3 percent so far this month, Asia’s worst performance after South Korea, the Philippines and Singapore, according to indexes compiled by HSBC Holdings Plc.

Rupee Drops

The rupee has slid 1.6 percent in January, the third-worst performance among Asia’s 10 most-traded currencies excluding the yen, on concern costlier oil prices will push up the import bill in an economy that buys about 75 percent of its fuel overseas. Crude-oil prices in New York, which reached a two-year high of $91.55 a barrel on Jan. 3, traded at $88.72 yesterday.

“There’s a risk of inflation becoming generalized due to the spill-over effect of higher oil and food prices,” Jay Shankar, an economist at Mumbai-based Religare Capital Markets Ltd., said in an interview yesterday. “If crude-oil prices go beyond $120 a barrel, it isn’t unlikely that the RBI may raise rates by as much as 175 basis points.” He expects the repurchase rate to climb 100 basis points to 7.25 percent by the end of the year.

The rupee dropped 0.2 percent to 45.45 per dollar yesterday, according to data compiled by Bloomberg. The currency will trade at 46 by the end of March and weaken to 47 by the end of the year, said Poddar, who was an economist at the International Monetary Fund before joining Goldman.

‘Politically Sensitive’

The cost of protecting the debt of government-owned State Bank of India, which some investors perceive as a proxy for the nation, has increased 9 basis points from the end of last year to 169 as pressure mounts on the government to curb gains in prices. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Indians voted out at least two federal governments and one state administration in the past 15 years after inflation reduced their purchasing power. The World Bank estimates 828 million Indians, or 66 percent of the population, live on less than $2 a day.

“Inflation is a politically sensitive issue,” N. R. Bhanumurthy, an economist at the New Delhi-based National Institute of Public Finance and Policy, said in an interview yesterday. “It’s imperative for the government to gain control over prices ahead of state elections.”