By Anoop Agrawal July 27 (Bloomberg) -- Indian bonds, Asia’s worst-performers in 2009, may keep tumbling through year-end as the central bank stops cutting interest rates and the government sells a record amount of debt, UBS AG said. The yield on the benchmark 10-year local-currency bond may climb more than 1 percentage point to a peak of 8 percent by end-2009, the highest since October 2008, said Ju Wang, an Asian fixed-income strategist at UBS. Investors who wait until then to buy the bonds would avoid a loss of 4 percent, according to Bloomberg calculations. Wang said the Reserve Bank of India, which meets tomorrow to review its monetary policy, will leave its benchmark interest rate unchanged and may signal in coming months that inflation is set to return by the end of 2009. Prime Minister Manmohan Singh’s government plans to sell an unprecedented 4.51 trillion rupees ($94 billion) of bonds in the fiscal year to March 31. “The supply increases the risk premium as India is running a huge budget deficit and domestic growth is relatively on a strong footing,” Singapore-based Wang at Switzerland’s biggest bank said in an interview. The yield on the 6.9 percent note due July 2019 climbed six basis points to 6.92 percent on July 24 after the government sold 120 billion rupees in its 15th auction for the fiscal year. Nine more sales are scheduled to be held before Sept. 30. A basis point is 0.01 percentage point. Worst Performers Indian government bonds lost 3.7 percent this year, the worst performance among 10 local-currency debt markets tracked by an index compiled by HSBC Holdings Plc. Central bank Governor Duvvuri Subbarao will leave the overnight lending rate, or the repurchase rate, and the reverse-repurchase rate unchanged at 4.75 percent and 3.25 percent tomorrow, according to 16 of the 18 economists surveyed by Bloomberg News. Two predict a quarter-percentage point reduction in both the rates. “If they do, they will have to quickly reverse it next year,” Wang said. Wholesale prices, India’s key gauge of inflation, have declined for six weeks in a row from a year earlier as the $1.2 trillion economy, Asia’s third biggest, expanded at the slowest pace in six years. Growth in industrial production accelerated to an eight-month high in May, signaling the slump may be easing. Monetization of Debt The central bank’s purchases of existing securities are increasing money supply, which can stoke inflation, and aren’t enough to prevent yields from rising this year, Wang said. The transactions shouldn’t be “confused with monetization” as they are a regular tool for “effective liquidity management,” the Finance Ministry said on July 9. “From the long-term point of view this is monetization,” Wang said. “It will fuel expectations of future higher inflation. I don’t think the central bank will continue this process. It only serves a purpose in the near term since inflation is low.” The monetary authority plans to buy 800 billion rupees of existing securities under its open-market operations in the first half of the fiscal year and has the option to buy more or less “as may be necessary,” according to a statement July 16. The Reserve Bank has bought securities worth 334.4 billion rupees so far this fiscal year, according to bank data compiled by Bloomberg. The benchmark 10-year yield has risen 0.86 percentage point since the central bank started buying securities from the secondary market on Feb. 19 to help the government complete its borrowing program. Spread to Narrow The gap between one- and five-year yields will narrow from near a record once the government puts in place measures to cut its budget deficit from 6.8 percent of gross domestic product, the highest in 16 years, and the central bank lifts interest rates to “anchor” inflation expectations, Wang said. The spread between the two maturities widened almost sevenfold this year to a record 2.60 percentage points on June 16 and was at 2.52 percentage points on July 24, according to data compiled by Bloomberg. “A further steepening will only reflect an irresponsible fiscal policy, which we don’t expect,” she said. “The present levels have the uncertainties priced in, but not the stability that is expected in the medium to long term.” To contact the reporter on this story: Anoop Agrawal in Mumbai at aagrawal8@bloomberg.net.

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