'Indian bond yields headed high; Inflation stays tall'

Even as the Reserve Bank of India takes a page out of the U.S. Federal Reserve’s playbook to push down borrowing costs, yields in the nation are headed higher as price pressures are unlikely to abate soon, according to Aditya Birla Sun Life AMC Ltd.

Inflation is expected to remain elevated over the next 6-12 months, said Maneesh Dangi, who oversees $23 billion of debt assets. That view is at odds with most economists who say last month’s spike in consumer prices will start to cool once new harvests come in.

An increase in inflation and fears of a wider fiscal deficit led to yields jumping in early December, prompting the RBI to resort to a Fed-style Operation Twist to cheapen long-term borrowings. Yields have eased since the first tranche was announced, but data last week showing a spurt in inflation to more than a five-year high has put the authority’s accomodative stance at risk.

“It is generally not wise to fight the RBI, but if fundamentals take rates higher it is better to be on the side of higher rates in the long run,” said Dangi. Benchmark 10-year yields will trudge toward 7% by June, he said. The yield was at 6.63% on Friday.

The RBI cited much higher than expected inflation when it surprised traders by keeping policy rates unchanged last month following five cuts totaling 135 basis points earlier in 2019.

Core to Dangi’s view is that reviving some of the stressed sectors of the $2.7 trillion economy -- like telecom -- has meant generating inflation in those segments as a likely solution. But in India, which is also the world’s third-biggest oil consumer, costs of everything from food to mobile-phone services have already been climbing.

“It won’t take long before it starts to develop its own feet,” he said. “And that’s a problem for the bond guy and the central bank.” Dangi said he is “hiding” in sovereign and corporate bonds maturing in two-to-three years.

Oil briefly rose above $70 a barrel this month for the first time since September amid tensions between the U.S. and Iran. While prices have since eased, they remain elevated compared with last year.

Dangi said he expects retail inflation to average 5% this year, above RBI’s 4% mid-term target.

The government is likely to end up with a shortfall of about 3.8% of GDP this fiscal year ending in March -- versus its target of 3.3% -- and about 3.5% in the next, as an economic slowdown hurts tax collections, he said.

The RBI has so far conducted three auctions under Operation Twist, buying 300 billion rupees of longer-tenor bonds while selling 253 billion rupees of 2020 debt. A fourth tranche for 100 billion rupees is due Jan. 23.

“It is the first time of sorts, RBI has come out to say that it will manage rates,” said Dangi. “The fact that Operation Twist is being flirted with in India suggests that when you are putting out a view that rates will trend up, you are fighting the RBI.”