June 30 (Bloomberg) -- India’s decision to scrap import duties on crude oil is stoking concern that the government will fail to rein in its budget deficit, depressing the rupee and pushing up yields on government debt.
The currency is headed for its first quarterly loss in a year, after weakening 0.6 percent against the dollar since March 31, the worst performance in Asia after the Thai baht’s 1.7 percent decline, according to data compiled by Bloomberg. Yields on 10-year government bonds have climbed 13 basis points from a six-week low of 8.19 percent on June 20.
The government’s announcement on June 24 ending the 5 percent duty on oil imports and cutting fuel levies will reduce revenue by 490 billion rupees ($11 billion), or 0.5 percent of gross domestic product, according to Goldman Sachs Group Inc. India’s budget shortfall was 4.7 percent of gross domestic product in the year ended March 31. Finance Minister Pranab Mukherjee is targeting a deficit of 4.6 percent for this fiscal year.
“The domestic situation is adding to the short-term vulnerability of the rupee,” Mitul Kotecha, the head of global foreign-exchange strategy in Hong Kong at Credit Agricole SA, said in an interview yesterday. “The scrapping of duties is being viewed with caution.”
The 26 percent advance in global oil prices over the past year prompted Prime Minister Manmohan Singh’s coalition government to raise prices on diesel and cooking gas for the first time in a year. Diesel prices were increased by 3 rupees (7 cents) a liter, kerosene was raised by 2 rupees a liter and cooking gas by 50 rupees for every 14.2 kilogram bottle.
Cushion the Blow
To cushion the effect of higher prices on inflation and to reduce the impact on a country where about 75 percent of the population lives on less than $2 a day, the government also cut taxes on fuel, further decreasing budget revenue.
The target to bolster tax revenue by 18.5 percent in the year through March 2012 will be a challenge as economic growth slows, Sunil Mitra, the top finance ministry bureaucrat said on June 8. Indian GDP rose 7.8 percent in the first quarter, the least for five quarters.
“We see the rupee on a weak footing in the next quarter as well since the fiscal situation will be worrisome and growth is likely to be disappointing,” said Anubhuti Sahay, a Mumbai- based economist at Standard Chartered Bank Plc. “It will be under pressure until September.”
Rupee-denominated bonds have provided the smallest returns to investors this quarter among so-called BRIC nation local- currency debt, according to the JPMorgan Chase & Co. GBI-EM Unhedged Index.
Rupee notes earned 0.3 percent, compared with 9.2 percent for Brazilian-real notes, 1.6 percent on Russian ruble debt, and 0.8 percent on on bonds denominated in Chinese yuan.
The difference in yields between sovereign rupee notes due in 10 years and similar-maturity debt in the U.S. widened to 524 basis points from this year’s low of 436 reached April 8.
The rupee trimmed its quarterly decline this month, gaining 0.4 percent to 44.8662 per dollar as global funds, lured by what is still the fastest growth rate among major economies after China’s, stepped up purchases of Indian assets. The Chinese economy grew 9.7 percent in the first three months of 2011.
Rising interest rates in India are also supporting the rupee, with the currency providing a total return of 1.6 percent since March 31, more than the 0.8 percent for the yuan, data compiled by Bloomberg show. Total return includes earnings on the currency as well as the interest earned on applying the local deposit rate. India has increased its benchmark rate by 275 basis points in the past year, more than Brazil, China and Russia.
“The downside is capped and the rupee will consolidate before appreciation,” J. Moses Harding, Mumbai-based executive vice-president at IndusInd Bank Ltd., said in an interview yesterday. “Capital inflows will continue due to prospects of carry-trade.”
In carry trades, investors borrow funds in countries with lower interest rates and then invest the money in markets with higher yields.
The rupee will appreciate to 44.50 per dollar next quarter and the yield on 10-year bonds will probably remain between 8.10 to 8.25 percent over the next six months, Harding said.
Excluding interest-rate returns, the rupee will strengthen 2.1 percent to 44 per dollar by the end of June 2012, according to the median forecast of 25 analysts surveyed by Bloomberg. The median prediction was 45.5 per dollar on June 9.
Overseas investors bought $3.4 billion of Indian debt this year, increasing outstanding holdings to $21.1 billion as of June 27, according to Securities and Exchange Board of India data. The outstanding equity investment was $102 billion. This month, investors purchased shares worth $562 million more than they sold, the data showed.
The cost of protecting debt of government-owned State Bank of India, seen as a proxy for the nation, has increased 17 basis points this month to 197, according to data compiled by CMA, which is owned by CME Group Inc and compiles prices quoted by dealers in the privately negotiated market.
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.
Reducing the budget deficit to the government’s target level will be difficult, Chakravarthy Rangarajan, chairman of the prime minister’s Economic Advisory Council, said June 27 after the fuel tax reductions were announced.
Crude climbed 2.4 percent to $95.16 a barrel in New York trading yesterday, and has gained 13 percent since hitting $83.85 on Feb. 15, the lowest level this year.
“There won’t be any major fall in oil prices from the current level and so the pressure on the budget deficit to widen remains,” said N. R. Bhanumurthy, a New Delhi-based economist at the National Institute for Public Finance and Policy. “There has been some relief for the rupee lately and it has appreciated, but a major respite is unlikely.”
--With assistance from Anil Varma and V Ramakrishnan in Mumbai and Emma O’Brien in Moscow. Editors: Cherian Thomas, Emma O’Brien
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