A cash crunch created by the RBI to shore up the exchange rate caused short-term interest rates to exceed long-term ones, inverting the yield curve that gauges the length of investment against returns. Three-month government debt costs jumped to as high as 12 percent at the end of August, from 7.31 percent three months earlier. Two-year bond yields exceeded 10-year rates by as much as 272 basis points on July 31. Notes due in a decade pay 8.72 percent, compared with 2.63 percent in the U.S., 0.69 percent in Japan and 3.98 percent in China.

Inverted yield curves typically reflect investors’ lack of confidence in an economy and presaged bailouts in Europe in the past three years. Greece’s two-year debt started paying more than 10-year securities a month before the government sought financial aid for the first time in 2010, while Portugal’s curve inverted a week before it sought a rescue.

India aims to narrow the budget gap to 4.8 percent of GDP in the fiscal year ending March 2014. That goal looks difficult to achieve as government spending increases, according to UBS AG. Singh’s administration has proposed a $21 billion-a-year program to provide about two-thirds of India’s 1.2 billion people with low-cost grains.

Falling Confidence

“I am quite surprised that the downgrade hasn’t happened,” Bhanu Baweja, the global head of emerging-market cross-asset strategy at UBS in London, said in a Sept. 11 interview with Bloomberg TV India.

Standard Chartered Plc cut its forecast last month for gains in India’s gross domestic product in the year through March 2014 to 4.7 percent from 5.5 percent. CLSA Asia Pacific Markets and Goldman Sachs have lowered their estimates twice this quarter with CLSA now expecting 4.2 percent. Singh’s economic advisory body reined in its growth forecast this month and signaled interest rates wouldn’t fall until the rupee stabilizes and inflation eases.

“With the right mix of reforms and improvements in governance, GDP growth could stabilize in years to come provided macro policy remains prudent,” PIMCO’s Mieth said.

Savings Pool

India’s domestic savings have helped cap increases in public debt costs and the economy’s limited reliance on foreign borrowings has made it less vulnerable to currency risk, according to Moody’s Investors Service.

“Because of relatively high savings, the yields paid by the government haven’t shot up so dramatically that its repayment capacity is at risk,” Atsi Sheth, an analyst in New York at Moody’s, said in a Sept. 18 interview. “The rupee depreciation doesn’t significantly and immediately affect India because foreign-currency debt is about 6 percent of its total debt.”