Indian Debt Fails to Shine
Yields Are High, but Swings in Rupee Are Dizzying
By SHEFALI ANAND CONNECT
Jan. 1, 2014 9:43 a.m. ET
Investors are giving Indian debt a pass, even as policy makers hope to have it included in a global government-bond index.
Global investors yanked a net $8 billion out of Indian debt in 2013, after adding money every year since 2006, according to figures from the Securities & Exchange Board of India.
Though Indian bond yields are high, at about 8.8% for the 10-year rupee-denominated government bond, rising domestic interest rates and the high cost of protecting against swings in the volatile local currency have made the debt unattractive to global investors.
"The case for holding Indian local currency bond is just not there," says Neeraj Arora, an emerging-market debt analyst at Boston-based MFS Investment Management, which manages $16 billion in emerging-market debt.
Analysts expect the Reserve Bank of India to raise interest rates in the coming months in a bid to curb inflation, which has risen above 7% since October. The central bank has raised its benchmark interest rate twice since late September, for a total increase of half a percentage point, to 7.75%.
Higher interest rates typically send the prices of existing bonds lower.
For foreign investors, betting on rupee-denominated debt also has become more expensive following a sharp decline in the Indian currency this summer. The rupee fell by more than 20% in four months, to a record low of 68.80 for one U.S. dollar in late August.
Investors were worried that the U.S. would cut its easy-money policies, reducing the flow of cash into emerging markets. That could have made it harder for India to fund its large current-account deficit, the difference between funds flowing into and out of the country for trade, investment and items such as foreign aid.
The rupee has recovered somewhat since September, partly as India took steps to increase its foreign-currency reserves and lower its import bill. The currency has gained slightly since the Federal Reserve said Dec. 18 that it would cut its bond purchases by $10 billion a month to $75 billion.
Analysts say that as the rupee has gyrated, the cost of hedging against the moves has risen as high as 7% to 8%, which eats into potential returns from rupee-denominated bonds. For foreign investors, "the arbitrage is not attractive enough," says Puneet Pal, fund manager at BNP Paribas Mutual Fund, the Indian asset-management unit of French bank BNP Paribas SA.
Still, investors may be forced to look at Indian debt more closely if India succeeds in its recent efforts to become part of a global bond index, such as the J.P. Morgan Government Bond Emerging Markets Global Diversified Index. Analysts say that if Indian debt is included, it would comprise as much as 10% of the J.P. Morgan index. Funds that track the index could end up investing $20 billion to $40 billion in Indian debt, according to an estimate by Standard Chartered STAN.LN 0.00% PLC.
At the moment, foreign investors own less than 2% of India's outstanding rupee-denominated government debt, partly because the nation restricts foreign ownership of Indian debt. Only $30 billion of investments in government bonds are permitted. Analysts say these restrictions would have to be removed completely for Indian debt to become part of its indexes. Discussions are ongoing, Indian government officials say.
Meanwhile, some global investors that already invest in Indian debt are waiting to decide on additional buying. Federal elections are due before the end of May, and investors are eager to see a stable government that will push economic overhauls, boosting growth.
The economy is expected to expand at less than 5% for the year that will end March 31, the slowest pace of growth since 2003.
"Post the elections, we need to see a really proactive government," says Katherine Renfrew, head of the emerging-market debt team at TIAA-CREF, which manages $7 billion in assets. Ms. Renfrew trimmed her exposure to rupee-linked Indian corporate debt in 2013 and isn't planning to add to it for now. She owns a small amount of dollar-denominated debt issued by Indian companies.
Credit-ratings company Standard & Poor's said in November that it would wait for the new government to unveil plans for boosting growth and curbing spending, before deciding whether to lower India's rating, now just one notch above speculative-grade, or "junk," status. That is a further concern for Ms. Renfrew.
"Any negative trigger can actually result in a downgrade," says Mr. Pal of BNP Paribas.
Analysts say that once the uncertainty of elections is over, companies will likely start investing again to expand their businesses. That would bode well for India in the later part of the year.
"In 2014, we expect more sustainable and stronger growth, partly led by investment," says Mr. Arora of MFS Investment Management. To benefit from this, Mr. Arora lately has been investing in the rupee, which he says has seen its worst because India has brought its current-account deficit under control.
"The currency will not depreciate from here and it will likely outperform the other emerging-market currencies," Mr. Arora says.
Investors like him also draw confidence from India's new central-bank governor, Raghuram Rajan, who took the helm of the Reserve Bank of India in September. A U.S.-trained economist. Mr. Rajan has said the central bank is committed to taming inflation, which he says will help boost the rupee's long-term value.
Write to Shefali Anand at
[email protected]
http://online.wsj.com/news/articles/SB10001424052702304858104579262400525807612
Trading Futures: Indices Vs Individual Stocks