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The Reserve Bank of India is facing conflicts in its dual role of fighting inflation and managing the government’s debt issuance, according to former governor Bimal Jalan.
The most-active 2022 bonds are headed for a third week of losses, with the yield reaching a two-month high of 8.18 percent as the Reserve Bank held the first government debt auction of the fiscal year on April 8 and prepared to meet to set monetary policy on May 3. Jalan, chairman of the Centre for Development Studies, said policy makers may be discouraged from raising interest rates to keep price increases in check.
Rupee notes have lost 0.6 percent this month, the worst performance among 10 Asian local-currency debt markets outside Japan, according to indexes compiled by HSBC Holdings Plc. A report will show today wholesale prices rose 8.36 percent last month, four times the rate in the U.S. and the highest among BRIC economies except Russia, according to the median forecast of 28 economists in a Bloomberg survey.
“There is always some tension and some trade-off if you’re managing government debt,” Jalan said in an interview on April 11. “If you’re a borrower, whether you acknowledge it or not, the only way is to try and keep interest rates lower than they should be.”
Price Pressures
The yield on 7.8 percent notes due April 2021 rose four basis points, or 0.04 percentage point, to 7.93 percent on April 13, according to data compiled by Bloomberg. India’s financial markets were closed yesterday. The yield on the 8.13 percent bond maturing in September 2022 climbed 14.5 basis points over three trading days to 8.195 percent.
The Reserve Bank raised 120 billion rupees ($2.7 billion) from the April 8 sale, which included new 10-year bonds. Inflation in the nation, where 66 percent of the population lives on less than $2 a day, has climbed from an 11-month low of 8.08 percent in November.
The difference in yields between the nation’s 10-year bonds and similar-maturity U.S. Treasuries has widened to 454 basis points from this year’s low of 436 reached on April 8.
“The RBI needs to be vigilant and look at whether these increases are becoming more persistent,” Namrata Padhye, a Mumbai-based economist at IDBI Gilts Ltd., said in an interview on April 13.
‘Conflict of Interest’
In the U.S., the Federal Reserve sets interest rates while the Treasury manages government issuance. Most OECD countries established independent debt-management offices in the 1980s and 1990s, while emerging-market economies including Brazil, South Africa and Argentinahave restructured public finances. Most countries “don’t have this sort of a problem, but in our situation it has evolved over years,” said Jalan, 70, who led the central bank from November 1997 to September 2003.
The Reserve Bank and the Finance Ministry have examined the separation of roles since 1991, with the central bank’s 2000-01 annual report “unequivocally” recommending the move. There is a “severe conflict of interest between setting short-term interest rates and selling bonds,” according to a finance ministry report in 2008. Finance Minister Pranab Mukherjee said in his budget speech on Feb. 28 the government will introduce legislation to set up an independent debt-management office.
“Establishing a separate debt office earlier would have helped,” said Deepali Bhargava, an economist at the Indian unit of ING Groep NV in Mumbai. “Maybe the Reserve Bank could have had a better hold on inflation today.”
Fiscal Deficit
Finance Minister Pranab Mukherjee aims to reduce the shortfall in the government’s finances to 4.6 percent of gross domestic product from an estimated 5.1 percent in the prior 12 months. TheInternational Monetary Fund estimates the gap in the government’s finances will be the highest among the BRIC economies at 8.5 percent of gross domestic product in 2011, including the gap in state government budgets. The central bank, which next meets on May 3, will raise the benchmark repurchase rate to 7 percent by end-June from 6.75 percent now, according to Royal Bank of Canada.
“The deficit is falling at a very slow pace and that just means that the onus is on the RBI to do all the work” on fighting inflation, Brian Jackson, an emerging-markets strategist at Royal Bank of Canada in Hong Kong, said in an interview on April 8. The deficit “is a consideration which guides how quickly they can go on interest rates,” he said.
The rupee has dropped 1 percent this week on speculation oil refiners stepped up dollar purchases to pay for costlier crude imports. Oil for May delivery was at $107.23 a barrel on the New York Mercantile Exchange, taking this year’s gains to 17 percent. The currency traded at 44.505 per dollar on April 13, according to data compiled by Bloomberg.
External Factors
“Inflation globally is being caused by a rally in commodity prices like oil,” said N.R. Bhanumurthy, a New Delhi- based economist at the National Institute of Public Finance and Policy. “The RBI has limited tools at its disposal to influence” external factors, he said.
The cost of protecting the debt of government-owned State Bank of India, which some investors perceive as a proxy for the nation, has increased three basis points to 166 this month, according to CMA prices. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
“The setting up of a debt management office is overdue, but at least it is getting done now,”Dharmakirti Joshi, Mumbai-based chief economist at Crisil Ltd., a unit of Standard & Poor’s Ratings Services, said in an interview on April 13. He predicts inflation will range from 7 percent to 8 percent over the next six months if oil prices drop to $90 a barrel.
To contact the reporter on this story: Tushar Dhara in New Delhi at tdhara1@bloomberg.net.
To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net.
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