I have watched India’s bond market from the sidelines over the years, bewildered at how the enthusiasm in the Indian financial community fails to translate into concrete price action in the markets.
The talk at the end of last year was of a sustained rally in bond prices following the idiosyncratic move of Prime Minister Narendra Modi to withdraw around 80% of India’s currency from circulation in the hope of curbing rampant corruption and forgery.
That shock announcement - it had all the hallmarks of the strongman leader with its lavish, narcissistic unpredictability - was supposed to herald a rate cut from the Reserve Bank of India, given that it left onshore banks awash with liquidity thanks to the tendering of soon to be obsolete paper currency.
Lots of people were caught in that particular bull trap when the Indian government yield curve did exactly the opposite.
Perhaps I shouldn’t be so harsh on Mr Modi. After all, India’s notorious corruption via its cash-based economy had to be stamped out eventually. But there is such a thing as finesse, and to visit such lumpen behaviour on financial markets always tends to have the opposite effect of the hoped-for intention.
THE INITIAL REACTION after the ban on high-denomination notes was no doubt desired: the 10-year government bond rallied almost 40bp after the notes’ withdrawal, to a near 7.5-year low, just shy of 6.5%, buoyed by the perception of a cut in short-term Indian lending rates and the knowledge that the Indian banking system was awash with the newly gifted liquidity of demonetisation.
Mind you, that bullish thinking was justifiable: at the end of last year when the bulls crowded out the Indian debt markets, the Reserve Bank of India had already eased rates by 175bp. Inflation had been declining and the demonetisation move had already apparently super-charged that disinflationary dynamic.
By last week the bears were out in force, helping push 10-year rates out to close to 6.9% in the context of a steepening yield curve, while the onshore primary market all but shut to issuance at anything beyond three years. The bull market in Indian debt which had commenced in November appears to have run its course.
Of course, such heightened sensitivity to rates is hardly surprising in the context of India’s bond markets. Little indication of full-scale reform or a fundamental shift in mindset has ever really troubled Indian credit. Regulation is onerous and the structural constitution of the financial authorities fragmented and best described as capricious. There is a strait-jacketed mindset in terms of ratings which permeates the institutional investor base and a leeriness towards opening up the debt landscape to offshore capital.
Interestingly, it was this stodginess towards financial innovation which was supposed to have saved India from the vicissitudes of the Global Financial Crisis. India’s financial authorities certainly claimed credit for keeping the financial excesses of the last decade at bay.
IN THE RECENT past it might have served the country to remain mired in a bygone era, but that era has gone for good. India’s financial sector should recognise that a new age of banking and financial services is developing, wherein risk is returning to the table, accompanied by seemingly inevitable items such as fintech, big data and the pressure exerted by non-bank finance.
I suspect that the bigger banks in India are getting the joke. Nevertheless, the upper echelons of government should resist the urge to intervene. The demonetisation efforts of Mr Modi may indeed have been necessary in the long run. But they should have been calibrated and telegraphed ahead of time.
Indeed, the kind of authoritarian control that I suspect will be the undoing of the Chinese debt markets should be avoided at all costs. The RBI’s independence, for instance, has been a primary virtue of India’s regulatory backdrop, frustrating though it has often been.
This does not mean remaining in a pre-colonial, risk-averse era, but rather it means embracing new products and technology by canny stealth. Rising financing needs linked to infrastructure development are creating a new sense of urgency.
It may be that the recent reversal of India’s bond market rally has more to do with the post-Trump US Treasury sell-off than any domestic factors. But India, more than most emerging markets, may counter the exogenous demons of the global capital markets with its own idiosyncratic inputs.
It is a massive democracy with a free-floating currency, a depth of institutional liquidity and an administrative financial structure that is ripe for profound reform. The highest echelons of government should treasure what they possess and act accordingly. If they can harness India’s potential, the recent rally in Indian debt should prove more than the usual boom-bust flash in the pan.
