By Unni Krishnan - Aug 26, 2011
For the first time in 15 months, traders in the swap market are anticipating the Reserve Bank of India will stop raising interest rates and may start to ease policy in the next year as the economy slows.
The cost to lock in one-year borrowing costs dropped below the central bank’s 8 percent benchmark rate this month for the first time since May 2010 and was 7.73 percent today, according to data compiled by Bloomberg. The gap has narrowed 58 basis points in August, compared with 110 in Brazil and 37 in China.
India’s central bank has boosted borrowing costs 11 times since March 2010, the most of the biggest emerging nations known as the BRICs. The bid to contain inflation will probably cut economic growth, according to Morgan Stanley and Standard Chartered Plc, which have both reduced their forecasts for India this year. Gross domestic product rose 7.6 percent in the three months through June, the least since the fourth quarter of 2009, according to the median estimate of economists surveyed by Bloomberg ahead of data next week.
“Swaps are signifying that the market is expecting the end of the rate-hike cycle as growth slows,” Vivek Rajpal, a Mumbai based fixed-income strategist at Nomura Holdings Inc., said in an interview yesterday. “Easing at some point of time is possible, but it may be in the form of liquidity-easing measures, not necessarily a cut in interest rates.”
Swap Movements
India’s swap rates, which are pegged to the overnight money-market rate, climbed to a three-year high of 8.37 percent on July 27, a day after the Reserve Bank unexpectedly raised borrowing costs by 50 basis points, or 0.50 percentage point. The cost needed to receive floating payments for one year dropped the most this month since December 2008 after traders pared expectations for rate increases on signs the global economy is slowing.
The one-year swap rate in Brazil is at 11.5 percent, one percentage point below the nation’s benchmark rate. In China, the 3.80 percent swap rate compares with the one-year deposit rate of 3.50 percent. In Russia, which doesn’t target one policy rate, the gauge is 5.31 percent, 52 basis points above the three-month MosPrime interbank rate, data compiled by Bloomberg show. Traders use swaps to guard against fluctuations in borrowing costs.
India’s bonds have rallied amid evidence Asia’s third- biggest economy is slowing. Manufacturing grew in July at the slowest pace in 20 months, the Purchasing Managers’ Index compiled by HSBC Holdings Plc and Markit Economics showed this month. Car sales fell in July from a year earlier for the first time since January 2009, the Society of Indian Automobile Manufacturers said on Aug. 10.
Bond Returns
The yield on benchmark 7.8 percent rupee-denominated notes due in April 2021 has dropped 17 basis points this month to 8.28 percent, according to the central bank’s trading system. The yield rose three basis points today before a debt auction, where the central bank will sell 110 billion rupees ($2.4 billion) of securities due in 2018, 2021 and 2027, according to the government’s debt calendar.
India’s bonds due in 10 years yielded 600 basis points more than similar-maturity U.S. Treasuries yesterday, down from a record-high 621 basis points reached on Aug. 18. Sovereign rupee notes returned 1.7 percent this month, outperforming four of 10 Asian debt markets, according to indexes compiled by HSBC.
The central bank may signal it is equally concerned over slowing growth and inflation when it meets next on Sept. 16, according to Mumbai-based Religare Capital Markets.
Growth Outlook
India’s economy may expand 7.2 percent in the year through March, compared with an earlier prediction of 7.7 percent, Morgan Stanley said on Aug. 1. Standard Chartered cut its forecast on July 26 to 7.7 percent from 8.1 percent. Increases in wholesale prices, which have held above 9 percent for eight months, will retreat to 7 percent by March, the Reserve Bank said in a statement on July 26.
“The RBI’s predominant concern until now was inflation, but now growth is also suddenly coming on the radar,” Jay Shankar, a Mumbai-based chief economist at Religare Capital, said in an interview on Aug. 24. “I hope they won’t raise rates in September.”
Policy makers will need to raise borrowing costs aggressively to attract global investors, according to Mumbai- based IndusInd Bank Ltd. International funds’ holdings of rupee debt totaled $21.7 billion as of Aug. 24, according to the Securities & Exchange Board of India, below the $50 billion ceiling set by the government.
‘No Option’
“To attract global investors you need to keep inflation below the growth rate,” J. Moses Harding, a Mumbai-based executive vice president at IndusInd Bank, said in an interview on Aug. 24. “I think the RBI has no option but to deliver a half percentage point rate hike in September.”
Harding predicts that the 10-year bond yield will be about 8.15 percent by December.
The rupee has dropped 4 percent this month, headed for the biggest slide since May 2010, as exchange data show global funds reduced holdings of Indian stock by $2 billion. The currency was little changed at 46.0738 per dollar today, according to data compiled by Bloomberg.
The cost of insuring the debt of State Bank of India against default using five-year credit-default swaps has climbed this month. The contracts rose 81 basis points to 273, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in privately negotiated markets.
The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.
The central bank will raise borrowing costs by 25 basis points in September before pausing for the rest of the year, Shubhada Rao, chief economist at Mumbai-based Yes Bank Ltd., said in an interview on Aug. 23.
“While we expect RBI to remain significantly hawkish in its tone, we believe that the interest-rate cycle is close to peaking,” Rao said.
To contact the reporter on this story: Unni Krishnan in New Delhi at ukrishnan2@bloomberg.net
To contact the editor responsible for this story: Stephanie Phang at sphang@bloomberg.net
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