Price shock has ICICI Prudential Life's exec expecting hawkish RBI in Aug

India’s central bank may signal the start of a normalization of its accommodative monetary policy at its August meeting amid accelerating inflation and risks from surging oil prices, according to ICICI Prudential Life Insurance Co.

“We need to prepare ourselves for a rise in interest rates, starting with a rise in the reverse repo rate,” said Arun Srinivasan, head of fixed income at the company, one of India’s top private life insurers, that manages funds worth 2.14 trillion rupees ($29 billion) “The signs point to it.”

India’s retail inflation crossed outside the central bank’s 2%-6% comfort zone recently, pushing yields higher on fears the Reserve Bank of India’s policy tone will change as early as August in the direction of normalization. Surging oil prices are adding fuel to the fire given the country’s dependence on imports.

“The market found it very difficult to digest the inflation numbers, and we don’t see commodity prices coming down, especially oil,” said Srinivasan, who expects the RBI to first start draining liquidity using reverse repos, followed by a hike in the reverse-repo rate, and eventually a hike the benchmark interest rate after March 2022.

Bonds have already started pricing in a tighter monetary policy. The yield on benchmark 10-year note has jumped more than 10 basis points this month, as has that on the five-year note. The sell-off in bonds was also driven by the RBI not including liquid papers in this week’s bond-purchase plan.

Srinivasan expects the benchmark 10-year yield to rise to as high as 6.45% by March 2022, with range of 6.30%-6.45%. The yield on 10-year paper was little changed at 6.18% on Wednesday, while that on the five-year bond fell one basis point to 5.82%.

Consumer-price inflation probably jumped to 6.8% in June from 6.3% in May according to Bloomberg Economics’ estimates before data due on Monday.

A further rise in inflation in June would decrease the Reserve Bank of India’s comfort with its accommodative stance, said Abhishek Gupta, Bloomberg’s India economist. “Even so, we expect it to tolerate above-target inflation and keep its focus on reviving growth in the near term.”

Given the uncertainty around inflation and the path of the RBI’s policy, “our view is to run cash till the next policy and then look at the 4-year or 7-year segment, because that is the segment which is relatively well priced for a hike in yields,” said Srinivasan, adding he also likes state government debt.

Here are some more views from Srinivasan:

India’s potential inclusion in global bond indexes could be a “silver lining” in a rising interest rate scenario, and help support the government’s borrowing program in the second half of the year.

If 10-year yields climb to 6.20%, there’s no reason for foreign investors not to jump in, which is something the “RBI requires if they want to complete this year’s borrowing programs without canceling any more auctions because domestic demand is limited.”