Swaps Climb to 2008 High as RBI `Desperate' to Raise Rates: India Credit

The cost of locking in five-year interest rates in India has climbed to the highest level since 2008 as investors brace for the central bank to resume Asia’s most-aggressive tightening of monetary policy.

The fixed rate to receive floating payments for five years in a swap contract surged 118 basis points in the past year, the most in Asia, to a 27-month high of 8.09 percent on Jan. 20, data compiled by Bloomberg show. The Reserve Bank of India will boost its repurchase rate tomorrow by 25 basis points to 6.5 percent, according to 21 of 22 economists in a Bloomberg News survey.

Central bank Governor Duvvuri Subbarao said at a ceremony in Mumbai on Jan. 17 he is “desperate” to cool inflation that accelerated the most in 10 months in December to 8.43 percent. Deutsche Bank AG forecast this month that rates on India’s 2016 swaps, already twice as high as the 4.15 percent for the similar gauge in China, will advance further as investors use the contracts to guard against higher debt costs.

“A 50-basis-point rate increase is probably what’s needed to bring inflation under control and the swap market is telling you just that,” K. Ramanathan, chief investment officer at ING Investment Management Pvt. in Mumbai, said in a Jan. 20 interview. “Monetary policy so far seems to have stayed a bit too pro-growth than was necessary.”

Mumbai-based Credit Analysis & Research Ltd. predicted a 50 basis point increase, a move HSBC Holdings Plc and JPMorgan Chase & Co. also said is possible.

Rate Move

The last time swap rates surged this high, in June 2008, the RBI raised rates by 0.50 percentage point twice in as many months. An increase of that size would be larger than each of the six quarter-point increases of 2010.

Five-year swap rates have gained 65 basis points since the last policy review on Dec. 16, when Subbarao left borrowing costs unchanged after share sales by companies including Coal India Ltd. caused a cash crunch in the banking system.

The Reserve Bank lifted the repurchase rate, its overnight lending rate, by 150 basis points last year, the most by any central bank in Asia. Brazil increased its benchmark on Jan. 19 for the first time since July, to 11.25, while South Korea and Thailand raised rates this month to 2.75 and 2.25. A basis point is 0.01 percentage point. The RBI’s decision will be announced in Mumbai at 11:30 a.m. tomorrow.

‘Out of Hand’

“The RBI is likely to raise rates by 25 basis points but there’s an outside chance of them surprising with a 50 basis points increase,” Jahangir Aziz, the Mumbai-based chief economist at JPMorgan who previously worked at the finance ministry, said in a Jan. 21 interview. “If inflation isn’t subdued at this point in time, it will get out of hand.”

The South Asian nation’s sovereign bonds have lost 0.9 percent this month, the third-worst performance after local- currency debt markets in Indonesia and the Philippines, HSBC indexes show.

India’s 7.8 percent bonds due May 2020 are headed for their first monthly loss since October, pushing yields close to the highest level since the notes were issued in May. The yield on the security rose three basis points to 8.16 percent on Jan. 21, according to the central bank’s trading system.

“Inflation will remain a worry in 2011,” Kumar Rachapudi, a Singapore-based fixed-income strategist at Barclays Plc, said in a Jan. 19 interview. “With no clear respite in sight for interest rates due to sticky inflation, we see the yield on the benchmark bond rising above 8.4 percent” by the end of June.

Real Yields

Real yields on nine-year government bonds, adjusted for inflation, ended last week at a negative 0.27 percent, compared with a positive 0.45 percent a month earlier, as the benchmark wholesale-price index rose faster. In China, 10-year real yields are a negative 0.61 percent.

“We are still bearish on India,” Adeline Ng, who oversees $1.6 billion in Singapore as head of Asian fixed-income trading at BNP Paribas Investment Partners, a unit of France’s largest bank, said in a Jan. 19 interview. “Central banks will still hike rates, partially to normalize rates where many of the countries are still having negative interest rates.”

The BNP Paribas L1 Bond Asia Ex-Japan fund uses interest- rate swaps to profit from its forecasts.

Inflation in India is being stoked by the higher cost of farm products. The food-inflation rate rose 15.5 percent in the week to Jan. 8 in Asia’s third-largest economy, undermining spending power in a country where the World Bank estimates 828 million people live on less than $2 a day.

Political Pressure

The main opposition Bharatiya Janata Party started a month- long campaign on Jan. 20 against Prime Minister Manmohan Singh’s government for failing to check price gains. The government is targeting economic growth of 9 percent over the next two decades to cut poverty.

Singh, who is under pressure to cap prices before his Congress party faces nine state elections in the next 18 months, said Jan. 19 he’s “confident” of slowing inflation by March. Chakravarthy Rangarajan, the top economic adviser to Singh, said Jan. 7 that “some action” on rates may be needed to contain prices.

The cost of protecting debt of State Bank of India from default for five years rose 23 basis points to 183 this year. Some investors use State Bank as a proxy for sovereign credit- default swaps. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to debt agreements. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

India’s rupee fell 0.2 percent to 45.62 per dollar on Jan. 21. The currency rose 4.1 percent in 2010 after gaining 4.9 percent in 2009, and slumping 19 percent in 2008.

“With inflation remaining above its comfort level, the RBI needs to demonstrate strong resolve to tackle it in order to maintain credibility,” Anubhuti Sahay, a Mumbai-based economist at Standard Chartered Plc, said in a Jan. 18 interview.