India rates: Inflation worries

Bonds are watching inflation.
Eugene Leow31 Aug 2021
    Photo credit: Unsplash Photo

    Indian government bond pricing is now assigning a greater weight towards inflation worries. We think that this makes sense given that growth risks have receded since the Delta variant wave appears to have peaked. Daily COVID-19 cases have dipped below 50k, from over 400k at the peak of the crisis in May. With reports indicating that two-thirds of the population may already have antibodies against the coronavirus and the daily vaccination drive picking up, we argue that India may be one of the best placed in emerging markets to recover. 

    Risks of another COVID-19 wave notwithstanding, we think that the bond market will increasingly focus on inflation risks. India’s headline CPI has nudged above 6%you for two consecutive months before easing in July. While base effects would turn more favourable out to December (pushing down headline figures), market participants and policy makers are unlikely to be able to shake off their discomfort with rising prices. At the last Reserve Bank of India (RBI) meeting, one dissent on the stance and upward revision is the inflation forecast is expected to spur an internal debate over the policy direction.

    Compared to the largest EM economies, the RBI appears slightly behind on normalisation plans. Brazil has hiked rates by 325bps since the start of the year. Note that the policy rate is already above pre-pandemic levels (which we peg at the start of 2020). Similarly, Russia has hiked rates by 225bps this year and the policy rate is also above pre-pandemic levels. Lastly, China normalized back in mid-2020. The INR Rates space has already factored in an increase in the interbank rate back above pre-crisis levels in two years. Having factored in 50bps worth of hikes in 2H22, we think that this pricing is reasonable, but risks are probably skewed to the upside. On a relative basis, we think that India government bonds could underperform IndoGB, playing on a likely policy divergence between the RBI and Bank Indonesia (more focused on growth).    


    Eugene Leow

    Rates Strategist - G3 & Asia

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