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India's Sovereign Bond Market In Trouble As Inflation Rebound Surprises

DATE POSTED:November 14, 2017

Another day and another Indian inflation reading comes in “hotter” than markets expected. Yesterday, India’s CPI printed at 3.58% for October 2017 - its highest level in seven months - versus the consensus expectation of 3.43%. The September 2017 reading was 3.28%, itself marking a strong rebound from the recent low of 1.46% in June 2017. Market chatter was that the prospect for a rate cut by the Reserve Bank of India (RBI) when it meets on 5-6 December 2017 was fading.

That prospect faded further today with the release of the wholesale price data for October 2017. The 3.59% year-on-year increase was well above the consensus estimate of 3.01%. As with the CPI, the rebound in energy prices was a major factor in the surge in wholesale prices. Fuel, power and lighting prices rose by 10.52% year-on-year, food prices rose by 4.30% and manufactured products by a more modest 2.62%. The latest CPI and wholesale price data should, however, provide the RBI’s monetary policy committee with the clarity it’s wanted on the inflation path, even if the growth outlook remains more opaque. According to Bloomberg.

This will be the last price print for the Reserve Bank of India before its Dec. 6 decision. Minutes of the previous meeting showed cracks within the monetary policy committee are widening as members disagreed sharply over the path for growth and inflation, resulting in five of the six voting to hold the benchmark repurchase rate at 6 percent until there’s more clarity. The RBI had also raised its inflation forecast and lowered the growth prediction for the year through March, as the lingering effects of last year’s shock cash ban combined with the disruptive roll out of a new nationwide sales tax and climbing global oil costs. Focus now shifts to India’s gross domestic product data for July to September, due Nov. 30. "Inflation has sequentially hardened more than what we had expected," said Rupa Rege Nitsure, Mumbai-based chief economist at L&T Finance Holdings Ltd. said by phone. "The rise in food prices in tandem with hardening fuel prices and a revival in the US markets will keep the RBI’s hands tied -- any chance of a rate cut is now remote."

The inflation data had a negative impact on what has been a surging Indian equity market in 2017, as Bloomberg notes.

India’s stock benchmark was poised to fall for a second straight day after accelerating inflation tempered expectations of a rate cut by the central bank. The S&P BSE Sensex dropped 0.3 percent to 32,945.11 as of 12:25 p.m. in Mumbai, with Larsen & Toubro Ltd. leading losses after lowering a forecast for future orders. The index has climbed 24 percent this year, repeatedly setting records, and sparking concern the rally has gone too far too fast. Data released late Monday showed consumer prices in October rose at the fastest pace in seven months, and may accelerate further amid rebounding oil prices. The Reserve Bank of India meets next month to rule on rates.

 

A “higher inflation trajectory may reduce room for RBI to cut rates,” said Soumen Chatterjee, head of research at Guiness Securities Ltd. “Investors are booking profits as the earnings season is drawing to a close and valuations look uncomfortable.”

 

The NSE Nifty 50 fell 0.4 percent. Forty seven of its constituents have reported quarterly results and of those 28 have met or exceeded analyst expectations, according to data compiled by Bloomberg. That’s helped push the Nifty up 24 percent this year and its valuation to the highest since 2010.

However, the inflation concerns in the Indian economy have been driving a sell-off in the Indian government bond market since the Summer – a sell-off which has accelerated in the last few weeks.

With the 10-year Indian yield testing the 7.0% threshold, Bloomberg notes.

Sovereign bond traders’ worries about inflation are intensifying…

 

Not surprisingly, the yield on the benchmark 10-year notes climbed above 7 percent Tuesday for the first time since last September. The yield could reach as high as 7.10 percent, according to IDFC Bank Ltd. Nomura Holdings Inc. is predicting CPI to rise above 4 percent this month, and to stay above the Reserve Bank of India’s 4 percent target through 2018. Sovereign bonds have been under pressure on concerns rebounding oil prices would widen the government’s budget deficit, forcing it to boost the size of debt sales just when state administrations are borrowing heavily and the central bank is selling debt to suck out excess liquidity from the system.

India is far from alone in the recent emerging market debt sell-off, the question now is when equities follow suit - maybe India's Sensex will show the way.