Money market rates at a two-year high are making the shortest-term debt investments more popular than stocks, bonds and gold amid a cash crunch at banks.
The yield on one-year treasury bills rose to 6.55 per cent on September 24, about the highest level since December 2008 and 26 times the rate on similar-maturity US Treasuries, data compiled by Bloomberg show. Short-term debt funds took in Rs 53,200 crore in the first eight months of the year, or 75 per cent of the amount asset managers raised, according to the Association of Mutual Funds in India.
India’s bills pay the most in Asia except Vietnam as central bank Governor Duvvuri Subbarao cuts money-supply growth to the slowest rate since 2005 to fight inflation. While policymakers in the US and Japan are injecting cash into economies where rates are already near zero, the Reserve Bank of India (RBI) has raised borrowing costs five times this year, more than any other monetary authority in the region.
“Short-term debt yields look quite attractive,” Navneet Munot, who oversees $8.5 billion as chief investment officer at Mumbai-based SBI Funds Management, a unit of the nation’s largest lender, said in a September 23 phone interview. “Yields are now at a peak because the worst of inflation is behind us.”
Bills versus bonds
Rates on one-year government debt in India have jumped 1.97 percentage points this year, heading for a record annual surge and dwarfing the 28 basis-point increase in the yield on 10-year debt to 7.87 per cent. The difference, or yield curve, narrowed to 1.32 percentage points from a record 3.44 percentage points in December 2009.
India’s treasury bills returned an annualised 3.6 per cent since December 31, beating the 3.2 per cent for bonds, Bloomberg calculations based on indexes compiled by the National Stock Exchange of India and Bank of America Merrill Lynch show.
Gains in the benchmark Sensitive Index of the nation’s shares slowed to 16 per cent this year from 74 per cent in the year-earlier period. Gold has advanced 18 per cent in 2010.
Indians added Rs 25,400 crore to bond funds and pulled out Rs 7,600 crore from equities in the eight months through August, according to data from the Association of Mutual Funds.
The government and banks are paying higher rates for short-term borrowing because the central bank is restricting funds as demand for credit increases. Bank notes, or certificates of deposit, due in a year offer 8.05 per cent, exceeding 10-year bond yields across Asia excluding Pakistan. Comparable company debt has a rate of 8.43 per cent, Bloomberg data show.
Money supply, rates
Annual growth in bank lending accelerated to 20 per cent in August from a 12-year low of 9.5 per cent in October 2009, according to central bank data.
Yearly expansion in money supply slowed to 15 per cent this month from 20 per cent a year earlier as Subbarao raised the benchmark reverse repurchase rate by 1.75 percentage points this year to five per cent, RBI data show. The measure is set for the biggest annual increase since it was introduced in 2000.
The central bank will boost rates at least 50 basis points more in the year ending March 31, ING Investment Management Pvt, predicts an Indian venture of the biggest Dutch financial-services company.
Rising borrowing costs have helped lower the nation’s inflation rate, measured by wholesale prices, to 8.5 per cent in August from a 20-month high of 11 per cent in April. The central bank estimates the pace of price gains, still the fastest in Asia except Pakistan, will slow to six per cent by March.
ING Forecast
“We’ll see more inflows into short-term debt funds as RBI continues to keep liquidity tight,” K Ramanathan, who helps manage the equivalent of $316 million in Mumbai at ING Investment, said in an interview on September 18. “As the central bank raises interest rates, money-market rates will climb.”
The difference between one- and 10-year bond yields would shrink to one percentage point as the shorter-term rate increased faster, he said, without specifying a time frame.
India’s reverse repo rate of five per cent is the highest in Asia excluding Indonesia and compares with benchmark rates of zero to 0.25 per cent in the US, 7.75 per cent in Russia and 10.75 per cent in Brazil. Asia’s third-biggest economy grew 8.8 per cent last quarter from a year earlier, the most since 2007.
RBI’s decision on whether to raise rates further would depend on the pace of price increases as borrowing costs are near their “neutral” level, Governor Subbarao said on September 20 in the southern city of Hyderabad.
Cash at banks
Cash at India’s banks declined in the year that began April as the government pursued a $99-billion borrowing programme and companies paid $23 billion in licence fees for wireless-phone services. The rate at which banks lend to one another overnight rose to as high as 6.4 per cent on September 22 from 3.3 per cent at the start of the year.
Investors may benefit from the surge in money-market rates by agreeing to receive fixed one-year rates in exchange for variable payments in a so-called interest-rate swap, according to Credit Agricole Corporate and Investment Bank, a unit of France’s second-biggest bank. The one-year swap rate, which has gained 1.38 percentage points this year, was at 6.45 per cent on September 24.
“We believe that the market is overestimating the hawkish bias of the Reserve Bank and underestimating the potential for improvement in liquidity in the second half of 2011,” Darius Kowalczyk and Frances Cheung, Hong Kong-based strategists at Credit Agricole CIB, wrote in a research note on September 22.
Relative yields
Ten-year bond yield is the highest among major economies except Brazil, where similar-maturity notes pay 11.75 per cent. Comparable securities offer 7.62 per cent in Russia and 3.32 per cent in China and 2.61 per cent in the US.
The difference in yields between India’s debt due in a decade and 10-year Treasuries was 5.26 percentage points on September 24, little changed from a week earlier. The measure, which has averaged 3.18 points in the past decade, reached a two-year high of 5.56 points on August 26.
One-year bills now yield 6.26 percentage points more than the three-month dollar London interbank offered rate, a measure of funding costs for global investors that is currently 0.29 per cent, Bloomberg data show. The spread is about the widest since September 2008.
Foreign holdings of India’s corporate and government debt more than doubled in 2010 to a record $17.4 billion on September 23 as yields climbed. Accelerated investment inflows helped the rupee strengthen four per cent against the dollar this month, the best performance among Asia’s 10-most traded currencies.
“The strong capital inflows will help ease the cash crunch in the coming months,” SBI Funds’ Munot said. “That will boost short-term debt prices, and investors who already own them will gain.”
Indian banks’ loans rose Rs 31,500 crore in the two weeks ended September 10, raising outstanding advances to Rs 33.8 lakh crore, central bank data showed September 24. Loans to industry and consumers rose Rs 27,700 crore during the period, while food credit rose Rs 3,830 crore. Credit rose 19.8 per cent, or by Rs 5.58 lakh crore, in the 12 months through September 10.
