RBI Faces ‘Major Challenge’ in Managing India Borrowing Program

Oct. 23 (Bloomberg) -- India’s central bank said it faces a “major challenge” in managing the government’s debt sales, which have fueled a record jump in bond yields this year and made it “difficult” to keep prices stable.

The surge in bond yields conflicts with the low-interest rate “regime” that the Reserve Bank of India is maintaining to revive economic growth, the bank said in an annual report published yesterday. The government predicts gross domestic product will increase 6 percent in the fiscal year through March, the weakest performance since 2003, and policy makers have kept benchmark rates at record lows since cutting them six times between October 2008 and April 2009.

“The bond market is already pricing into yields the odds of a reversal in the Reserve Bank’s easy monetary policy, with inflation and growth now rebounding,” said Baljinder Singh, a fixed-income trader at state-owned Andhra Bank in Mumbai. “The central bank will start raising rates in another three months.”

Benchmark 10-year government bond yields in India have risen 2.13 percentage points this year as the government stepped up issuance to fund stimulus needed to help the economy weather a global recession. India plans to raise a record 4.51 trillion rupees ($97 billion) via debt sales in the fiscal year through March to plug budget deficit estimated at 6.8 percent of gross domestic product, the most since 1994.

Prime Minister Manmohan Singh’s economic advisory council said Oct. 21 that India may “act earlier” than the U.S. and Europe in tightening monetary policy, forecasting inflation will accelerate to around 6 percent by the end of March. Governor Duvvuri Subbarao is likely to leave rates unchanged at the central bank’s Oct. 27 policy meeting, according to all 12 economists in a Bloomberg survey.

Inflation Accelerates

“Despite the Reserve Bank actively managing the liquidity in the system, the large increase in government borrowings has resulted in the hardening of yields,” the central bank said. “If governments continue to incur large fiscal deficits, it may be difficult for central banks to maintain price stability.”

India’s inflation accelerated more than expected in the week ended Oct. 10, a commerce ministry report showed yesterday. The wholesale-price index climbed 1.21 percent from a year earlier, after rising 0.92 percent the previous week. Economists forecast a 1.1 percent increase, a Bloomberg survey showed.

Faster “inflation could push the yield curve upwards,” the RBI said. “This could result in significant marked-to- market losses for fixed-income instruments, with potentially adverse implications for banks’ profitability.”

Banks are the biggest buyers of government debt in India, holding about 70 percent off outstanding securities.