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Rising inflation in India and the likely rate hike by the country’s central bank this week pushed the benchmark 10-year bond yield to a three-year high of 7.5004% on Monday. Indian bond investors are anticipating a rate hike of up to 50 basis points as rising crude prices have stoked fears of higher inflation and a slowdown in the economy.
Oil prices have been on an uptick since the past week as Saudi Arabia raised July crude prices anticipating higher demand as economies reopened after the Covid shock. Brent crude futures were up 19 cents, or 0.2%, at $119.70 per barrel at 0500 GMT on June 7, while US WTI Crude Futures hit a three-month high of $120.99 on Monday.
The worsening market sentiment is reflected by the rising bond yields, as sovereign Indian bonds represent a vast variety of credit products and will drive up borrowing costs across the economy while eroding equity valuations.
India’s 10-year benchmark 6.54% 2032 paper rose to a high of 7.51% on Monday morning, crossing the psychological barrier of 7.50% level. Rising Indian bond yields also mean bond prices are declining, which will eat into the bank’s profitability, prompting them to alter lending and deposit rates accordingly.
However, there is a likelihood of Indian bond yields rising even higher as crude oil prices edge upwards. The global supply crunch of oil could push inflation higher in India leading to even more rate hikes during the rest of the year. Alternately, investors are now exploring bonds in developed markets as yields are rising fast, prompting them to remove money out of India and invest in such high yield markets.
India’s dual problem
The Indian rupee has become one of the worst-performing currencies in Asia in 2022, and further depreciation is likely to be between 79 to 81 per dollar, analysts from UBS and Nomura Holdings predict. The Reserve Bank of India may try to rein in the currency as inflation rises, but this would in turn reduce the attractiveness of bonds.
“With US not yet relenting on moderating pace and quantum of rate hikes, and inflation not showing immediate signs of abating, it seems yet another slam dunk decision to hike rates in the upcoming policy. Quantum of rate hike (40-50bps in our view) will be a key determinant in extrapolating the terminal repo rate for FY 2023,” says Lakshmi Iyer, Chief Investment Officer (Debt) & Head Products, Kotak Mahindra Asset Management Company. “Though aggressive tightening is already discounted by the bond markets, the stance of the policy will continue to assume significance in the direction of bond yields,”
Now, the problem for India is juggling between a depreciating rupee, rising inflation, and rising Indian bond yields. Any further borrowing by the government will fuel a rise in yields, which means the government will have to pay back more in future, while it is already spending on old debt.
“The RBI will definitely use OMO (open market operations) purchases as an important tool to control yield upward movement, especially since the bond market is expecting one more CRR (Cash Reserve Ratio) hike worth 50 basis points in this financial year,” Venkatakrishnan Srinivasan, founder and managing partner at debt-advisory firm Rockfort Fincap, told local publication Moneycontrol.
