Bonds snap 2-day rally on rate hike fears

Indian bonds snapped a two-day rally as yields at their lowest in a month deterred buyers before an interest-rate decision by the Central bank later this month.

Ten-year bonds fell amid concern policy makers will raise interest rates to curb inflation when they meet on 31 January as Finance Minister Palaniappan Chidambaram today said manufacturing prices are rising.

The securities gained last week after the government said it would cut the size of a planned debt sale.

"We're going to see traders book profit on every rally,'' said Poonam Tandon, chief bond trader at Securities Trading Corp. of India, a primary dealer that underwrites government debt sales.

"We won't see too many buyers till we're clear what the central bank's assessment on inflation is.''

The yield on the benchmark 8.07 per cent bond due January 2017 rose 1 basis point to 7.49 per cent at the 5:30 p.m. close of trading in Mumbai, according to the central bank's trading system. A basis point is 0.01 per centage point.

The price fell 0.11, or 11 paise per Rs 100 face amount, to 104.01. Bond yields move inversely to prices. The 10-year yield may rise as high as 7.75 per cent this month, Tandon said.

Asia's fourth-biggest economy will expand close to 9 per cent in the fiscal year ending March 31, Chidambaram said, the fastest pace since the country gained independence from Great Britain in 1947. Central bank Governor Yaga Venugopal Reddy last year raised the overnight lending rate four times and also increased the amount of cash lenders must set aside to cover deposits in a bid to keep inflation between 5 per cent and 5.5 per cent.

Any decline in bonds may be tempered by optimism surplus cash at banks, the biggest buyers of government debt, will increase as overseas investors buy more local stocks.

Stock purchases by global funds rose to the highest since November last week, helping boost rupee funds held in the banking system.

Bonds may still gain on speculation banks, which are required by law to hold 25 per cent of their deposits in government debt, will purchase more securities as the amount they hold is close to the lower limit.

``There aren't too many sellers as banks are already close to the minimum amount of bonds they must hold,'' said Dhawal Dalal, who manages the equivalent of $2 billion in Indian debt at DSP Merrill Lynch Investment Management Ltd. in Mumbai.

"Liquidity is improving due to investment inflows into the stock market.'' The yield on the 10-year bond may drop to 7.35 per cent by the end of March, he said.

India's key inflation rate, as measured by wholesale prices, rose to 5.48 per cent in the week ended December 23, the most since October, the Ministry of Commerce and Industry said on January 5. ``While a decline in oil prices caps one side of the expectations, record lending and growth is a concern the central bank still needs to address,'' Tandon said. Crude oil prices have fallen 29 per cent from a July 14 peak of $78.4 a barrel.

Energy prices make up 14 per cent of India's wholesale price index, and as a net importer of the commodity, the South Asian country is vulnerable to price increases.