Auction Demand Supports Biggest Bond Rally in Nine Months: India Credit

By V. Ramakrishnan and Lilian Karunungan - Dec 2, 2011 9:29 AM GMT+0530

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The cost of permits for global funds to invest in India’s bond market has risen 53 percent since August 2010 on growing demand for notes of the third-largest developing economy.

International investors agreed to pay a record fee of at least 1.15 percent for the right to invest $5 billion in sovereign securities at a Nov. 30 auction in Mumbai, according to three people familiar with the matter. That compares with 0.75 percent in August last year. Yields on Indian government 10-year notes fell 14 basis points last month, the most since February, to 8.74 percent, while China’s declined 16 basis points to 3.66 percent.

Foreigners have raised holdings of rupee-denominated debt by 25 percent to $22.2 billion in 2011 and Prime Minister Manmohan Singh raised the cap on offshore ownership by 20 percent last month to $60 billion. Inflation will slow to 7 percent by the end of March from 9.73 percent in October, according to the central bank, following the most-aggressive round of rate increases among Asia’s 10 biggest economies.

“The yields are very high in India,” Rajeev De Mello, the Singapore-based head of Asian fixed income at Schroder Investment Management Ltd. who oversees $6.5 billion, said in an interview yesterday. “Indian bonds should start becoming more attractive as inflation comes down.”

Schroder Investment bid for both government and corporate debt at the sale, he said.
Curbing Volatility

The government raised the limits on foreign ownership of sovereign and corporate debt by $5 billion each, according to a Finance Ministry statement on Nov. 17.

Global investors can now hold as much as $15 billion of federal securities and $45 billion of corporate debt. Within the $60 billion cap, the amount that each foreign entity is allowed to buy is limited by the permits, or the quota system, that India uses to curb volatility in bond and rupee trading.

The maximum amount that a single fund could bid for was 20 billion rupees ($389 million) at the auction held by the Securities & Exchange Board of India on Nov. 30. The sale was oversubscribed by about 30 percent with $6.5 billion of orders, according to a Barclays Capital client note yesterday. Six calls made to the mobile phone of N. Hariharan, a Mumbai-based spokesman for the regulator, went unanswered.

India’s government bonds snapped a three-day rally today, with the yield on the 8.79 percent securities due in November 2021 rising two basis points, or 0.02 percentage point, to 8.72 percent, according to the central bank’s trading system.
Hedging Risk

The rupee depreciated 0.2 percent to 51.5750 per dollar, paring its first weekly gain since October. Three-month non- deliverable forwards, which allow investors to bet on exchange- rate movements, were at 52.46, from 52.29 per dollar yesterday.

Policy makers allowed investors, for the first time in 2011, to buy notes maturing in less than five years at the latest auction.

“The lack of tenor restrictions means investors can take lower-duration risk and also hedge currency risk easily,” Kumar Rachapudi, a Singapore-based interest-rate strategist at Barclays Capital, said in an interview yesterday.

Global funds’ ownership of rupee-denominated notes is headed for an 11th straight quarter of increase, according to exchange data.

India’s bonds returned 4.6 percent in the past year, underperforming six other regional markets, according to 10 Asian local-currency debt markets monitored by HSBC Holdings Plc. The yield premium on Indian 10-year debt over U.S. Treasuries is 663 basis points, 34 basis points off a record- high reached on Nov. 9.
Missed Forecasts

While India’s higher yields are attractive, investors need to take into account that the inflation rate has held above 9 percent since the start of December 2010, according to Mumbai- based Development Credit Bank Ltd. The Reserve Bank of India missed its target to keep wholesale price growth within 5.5 percent in the year ended March 2011.

“Inflation will continue to weigh on the minds of investors as we have missed forecasts in the past,” Anoop Verma, a Mumbai-based fixed-income trader at Development Credit Bank, said yesterday. “To that extent, relative returns will be lower on investments in government bonds.”

India’s bond risk surged the most since October 2008 last month on concern Europe’s sovereign-debt crisis will slow the global economy and crimp demand for Asian exports.
Rate Cuts

Five-year credit-default swaps on State Bank of India, viewed as a proxy for the nation, cost 351 basis points on Nov. 30, an increase of 85 basis points from the end of October, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in privately negotiated markets. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.

India’s gross domestic product grew an annual 6.9 percent in the three months through September, the least in two years, government data on Nov. 30 showed. Exports rose 10.8 percent in October from a year earlier, the least since October 2009, according to Commerce Ministry data released yesterday.

Slowing growth will spur the Reserve Bank to start cutting borrowing costs, according to Franklin Templeton Investment Trust Management Co. The central bank has raised its benchmark repurchase rate 13 times since the start of 2010 TO 8.5 percent.

“The outlook for bonds is positive as headwinds from the European Union will hurt growth,” Kim Dong Il, the Seoul-based chief investment officer for fixed income at Franklin Templeton, said in an interview yesterday. “That will prompt the central bank to cut interest rates by up to 150 basis points next year.”

To contact the reporters on this story: V. Ramakrishnan in Mumbai at rvenkatarama@bloomberg.net Lilian Karunungan in Singapore at lkarunungan@bloomberg.net

To contact the editor responsible for this story: Sandy Hendry at shendry@bloomberg.net
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