Bloomberg News

Default Swaps Jump Most in BRICs on Food Subsidy: India Credit

December 20, 2011

Dec. 20 (Bloomberg) -- India’s plan to boost food subsidies by 50 percent is threatening efforts to cut the budget deficit, extending the biggest jump in bond risk among the largest developing nations.

The cost to protect the debt of State Bank of India, seen as a proxy for the nation, against non-payment rose 234 basis points in 2011 to 395 basis points, the most in three years, according to data provider CMA. Credit-default swaps on China’s government bonds increased 78 to 146, while those for Russia climbed 124 to 270 and Brazil’s added 53 to 164.

Indian Prime Minister Manmohan Singh is tapping public finances to boost assistance as the economy of the nation, where the World Bank says more than 75 percent of the people live on less than $2 a day, slows. Nomura Holdings Inc. and Standard Chartered Plc predict Finance Minister Pranab Mukherjee will raise his borrowing target for a second time in the fiscal year ending on March 31.

“The passage of the food security bill may further pressure the government’s finances and push its borrowings higher,” A. Balasubramanian, the Mumbai-based chief executive officer of Birla Sun Life Asset Management Co. who oversees the equivalent of $12.1 billion in assets, said in an interview yesterday. “Given the persistent fiscal problems, the continuous supply of government debt will remain a negative factor for the market.”

India’s cabinet approved the Food Security Bill to grant the nation’s poor the right to buy food grains at discount rates, Information and Broadcasting Minister Ambika Soni told reporters in New Delhi on Dec. 18. The bill, aimed at meeting a pledge by the ruling Congress party to spread the benefits of economic growth, will need the consent of the parliament to become law.

Wooing Voters

Prime Minister Singh is betting on the legislation, the drafting of which was overseen by Congress party President Sonia Gandhi, to woo voters before elections in five states in the first half of next year. The government needs to boost food subsidies by 320 billion rupees ($6 billion) to 950 billion rupees a year to implement the policy, which will provide grains to 64 percent of India’s 1.2 billion-strong population, about 768 million people, Food Minister K.V. Thomas told reporters last week.

“The government’s eyes are on state elections next year and the upcoming federal election and hence we will see such populist measures,” Amol Agrawal, a Mumbai-based economist at STCI Primary Dealer Ltd., said in an interview yesterday. “Such measures may be good for the poor but will have negative implications for fiscal health.”

Rising Yields

The rising subsidy burden will force the government to increase its borrowings, maintaining “upward pressure” on sovereign bond yields, Agrawal predicts.

Ten-year government bond yields in India climbed 40 basis points, or 0.40 percentage point, this year, the most after Vietnam among Asian local-currency debt markets, as inflation accelerated and an economic slowdown threatened to crimp government revenue and stymie efforts to narrow the budget shortfall. Yields fell five basis points to 8.33 percent in Mumbai yesterday, according to the central bank’s trading system.

Finance Minister Mukherjee plans to cut the government’s deficit to a four-year low of 4.6 percent of gross domestic product by March 31, according to budget estimates.

Factory output in Asia’s third-largest economy fell 5.1 percent in October from a year earlier, the first contraction since June 2009, as the highest borrowing costs in three years damped demand for goods, government data showed this month. The $1.7 trillion economy expanded 6.9 percent in the three months ended September from a year earlier, the slowest pace since 2009, according to government data.

‘Downward Trajectory’

“Given that we are on a downward growth trajectory, the timing is not appropriate for coming up with policies like the food subsidy bill that add to the fiscal burden when revenues falter,” Vivek Rajpal, a Mumbai-based fixed-income strategist at Nomura Holdings, said in an interview yesterday.

Japan’s biggest brokerage predicts India’s government will borrow 300 billion rupees more than already planned in the year through March. Standard Chartered estimates the increase may be at least 400 billion rupees. The Finance Ministry last increased its annual debt-sale target by 13 percent in September to a record 4.7 trillion rupees ($88.5 billion).

Lower Tax Collections

India’s Finance Ministry said in a Dec. 9 report that lower tax collections in a slowing economy and delayed plans to sell stakes in state-owned companies mean it may miss its goal to narrow the budget gap. The economy may expand 7.25 percent to 7.75 percent this fiscal year, less than the 9 percent growth estimated in February, the report showed. Nomura’s Rajpal predicts the budget deficit will widen to 5.5 percent of GDP from 4.7 percent the previous year.

Reserve Bank of India Governor Duvvuri Subbarao has raised the benchmark repurchase rate by 375 basis points since March 2010 to curb inflation. Subbarao left the repo rate unchanged at a three-year high of 8.5 percent on Dec. 16, halting the fastest round of rate increases on record in the country.

DSP Blackrock Investment Managers and Credit Suisse Group AG predict that the Reserve Bank will cut rates in the first half of 2012 as inflation slows, joining central banks from Brazil to China in easing monetary policy. Brazil’s central bank has cut the Selic rate by a total 150 basis points since August to 11 percent, while the People’s Bank of China decreased the reserve ratio for banks by 50 basis points from Dec. 5, the first reduction since 2008.

Improving Bond Returns

Indian bonds are outperforming debt of the largest emerging markets this month as the central bank predicts inflation to slow to 7 percent by March from 9.11 percent in November.

Rupee-denominated notes have returned 2.22 percent in December, JPMorgan & Chase Co. data show. Local-currency securities lost 0.1 percent in Brazil and earned 1.1 percent in China and 0.04 percent in Russia.

“The outlook for bonds will improve over the next six months,” Ganti N. Murthy, the Mumbai-based head of investments at Peerless Mutual Fund, said in an interview yesterday. “Falling inflation may increase returns on fixed-income securities and prompt the central bank to cut rates from March or April.”

Murthy predicts the the 10-year bond yield will fall to 8 percent by the end of March. Yields have already retreated 67 basis points from a three-year high of 9 percent reached last month. Investors demand extra yield of 646 basis points to hold India’s 10-year notes instead of similar-dated U.S. Treasuries. The rupee fell 0.3 percent to 52.88 per dollar yesterday.

Election Pledge

Credit-default swaps on State Bank rose 44 basis points this month, according to data from CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. State Bank is viewed as a proxy for India by investors as the nation doesn’t have dollar-denominated debt.

The Food Security Bill will fulfill an election pledge by Singh’s Congress party in 2009 that it will supply 25 kilograms of rice or wheat at below-market rates to poor families each month should the party be voted back into power.

Every Indian falling within the so-called priority category will get 7 kilograms (15.4 pounds) of rice or wheat or millet a month, according to Food Minister Thomas. Rice may be sold at 3 rupees per kilogram, wheat at 2 rupees and millet at 1 rupee. That compares with market prices of 24 rupees a kilogram for rice in New Delhi and 15 rupees a kilogram for wheat, according to data provided by the Food Ministry.

“Once implemented, the food bill will add to the expenditure burden and thus to the fiscal deficit as revenue generation remains under pressure in the current low-growth scenario,” Anubhuti Sahay, a Mumbai-based economist at Standard Chartered, said in an interview yesterday.

--Editors: Anil Varma, Sandy Hendry

To contact the reporters on this story: V Ramakrishnan in Mumbai at; Kartik Goyal in New Delhi at

To contact the editors responsible for this story: Sandy Hendry at; Stephanie Phang at

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