Investors Rein in India Bond Optimism as Oil Prices Surge

Investors are holding back from going all in on Indian sovereign bonds even amid easing debt supply as rising crude prices threaten to reignite inflation concerns.

(Bloomberg) — Investors are holding back from going all in on Indian sovereign bonds even amid easing debt supply as rising crude prices threaten to reignite inflation concerns. 

“The second half of the year is generally good for bonds,” Devang Shah, co-head of fixed income at Axis Mutual Fund Co. said citing India’s typically smaller government debt issuance size in the latter half of the fiscal year. But rising crude prices are a “prominent risk,” he added.

He sees India’s benchmark 10-year yield climbing to 7.25% to 7.35% if oil prices jump to $92 to $95 per barrel. The benchmark yield climbed three basis points to 7.23% on Monday.

Brent crude’s surge above $90 a barrel last week due to extended OPEC+ supply cuts is threatening to fan inflation in India, which is a net importer of energy. That’s after the nation moved to ease food prices by curbing exports of rice and sugar, and imposed taxes on onion shipments after those prices pushed inflation to a 15-month high in July. 

“I am not too worried about food or the headline inflation as government policies would get the food inflation lower,” Shah said. “I’m more worried about crude oil.”

The Reserve Bank of India left its key interest rate unchanged for a third straight meeting in August. However, Governor Shaktikanta Das said last week the central bank will remain on guard on the second round effects of inflation. Even Bank of Korea has signaled it’s open to further rate hikes, and Bangko Sentral ng Pilipinas indicated it would be ready to adjust monetary policy to prevent a further broadening of inflation. 

“If oil stays around $95 per barrel, it would make sense to cut some duration,” said Puneet Pal, head of fixed income at PGIM India Mutual Fund. “If crude goes above $90 to $95 per barrel and stays there, it can add to the higher for longer rate theme.” He sees 10-year yields heading to as high as 7.40% if oil touches the upper end of that range.

Inflation data due Tuesday is likely to be watched closely, with CPI inflation seen slowing to 7.1% in August, according to economists surveyed by Bloomberg.

Markets are also monitoring other factors like any news on India’s bond index inclusion, the impact of monsoon rains on inflation and the trajectory of US yields to determine where bond yields are headed, according to Suyash Choudhary, head of fixed income at Bandhan Mutual Fund. He expects yields to stay rangebound and is overweight on three-to-six-year maturities.

India’s 10-year yield slumped as much as six basis points on Thursday as a report on the RBI seeking feedback from banks for settling rupee notes via Euroclear strengthened hopes that the nation’s bonds will be included in global indexes. The yield pared the move as traders waited for more concrete steps from the central bank.

“There is no real chance of inclusion in global bond indices as we are not open to removing investment limits for foreign portfolio investors and are not allowing bond settlements on Euroclear,” said Sandeep Bagla, chief executive officer at Trust Mutual Fund.

“Given that the inflation expectations are in the range of 5.25% to 5.50%, the 10-year yield should ideally trade closer to 7.50%. Higher oil prices could act as a catalyst for bond yields to trend higher,” Bagla said.

–With assistance from Marcus Wong.

(Updates with bond prices in third para and inflation estimate in 8th.)

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