India’s central bank may have to pay a bigger price for ignoring inflation by tightening interest rates much more aggressively later, like the Federal Reserve is doing now, according to the nation’s largest asset manager.
“If you don’t normalize gradually and preemptively, you may be in a situation down the line where you have to slam on the brakes,” said Rajeev Radhakrishnan, chief investment officer for fixed income at SBI Funds Management Pvt, which manages 4.6 trillion rupees ($60 billion).
The Reserve Bank of India has confounded market expectations with its accommodative policy even as inflation breached its 6% limit for two months. SBI Funds warn the global rout may hurt Indian bonds as the central bank downplays inflation risks amid surging oil prices and the market braces for record government borrowing.
“If you wait for growth to be 7% before thinking of normalizing, by that time policy action may be too late” because inflation has become entrenched, said Radhakrishnan, adding that he favors bonds with maturities of up to one year.
The Fed could have proceeded more gradually, he said, as the market is now pricing in about seven hikes this year. “The risk of something similar is there in India, though not to that magnitude.”
Bonds in India have been supported by a dovish RBI and lack of auctions since the end of February, though yields are set to rise as the government starts its planned record 15 trillion rupees of borrowing in April. Benchmark 10-year yields have climbed just five basis points this month, compared with about a 70-point jump for U.S. Treasuries of that maturity.
“There is a big gap between what the street thinks about inflation and what the RBI is projecting,” Radhakrishnan said. “A change in stance is warranted, but will it happen given what we have heard from RBI? I think it’s unlikely.”
The central bank’s next policy review is due on April 8. “One possibility is that in April the stance remains the same but at least they guide for a shift in the next review,” he said. “That can only happen if they acknowledge the inflation risk is much higher than what they have been anticipating.”