Swap market prices in more RBI rate cuts amid weak growth, low inflation

With inflation close to the Reserve Bank of India's target and growth weak, the country's overnight indexed swap (OIS) markets have started pricing in far more aggressive rate cuts by the central bank than previously anticipated.

OIS rates, the closest gauge of interest rate expectations, have eased by 10-15 basis points so far in March, with the absolute levels hinting at more than 50 basis points of rate cuts cumulatively over the next 12 months.

India's fiscal year 2025-26 begins on April 1.

"Inflation in the current quarter is tracking 50 bps lower than RBI forecast and that should provide the central bank a lot more conviction on the outlook for next year," said Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership.

"RBI may not wish for real policy rates to increase at a time there are downside risks to growth from global factors."

The primary dealership was expecting a shallow cycle of 50 bps cuts earlier, but now sees 75-100 bps of easing.

The one-year OIS rate stands around 6.10 per cent, its lowest level since August 2022, while the five-year rate was around 5.90 per cent, near its lowest level since March 2022.

"We continue to expect RBI to pivot towards growth. We now forecast RBI to cut rates by 25bps in April, and again in August and December, bringing the repo rate to 5.50 per cent," Japan's MUFG Bank said in a note.

"We think markets are underpricing the risks of reciprocal tariffs on India right now. While India is generally more domestically-oriented to begin with, reciprocal tariffs if raised to a meaningful level will still have a negative impact on India's growth prospects in 2025," they said.

A January Reuters' poll had forecast only two cuts in the current easing cycle.

Analysts also expect the central bank to infuse more rupee liquidity into the banking system alongside the rate cuts as it is the only way to ensure quicker transmission of lower rates to the broader economy.

The RBI has infused over ₹6.8 trillion of liquidity into the banking system since the middle of January.

Inflation data continuing to surprise on the downside will provide RBI continued space to follow up with a rate cut at the April meeting, and "the RBI could shift their stance from neutral to accommodative," JPMorgan said in a note on Tuesday.

JPMorgan still sees value in government bonds and will stick with its overweight stance. Foreign investors have net bought government bonds worth ₹14,300 crore ($1.67 billion) so far in March.

India's retail inflation eased to a seven-month low of 3.61 per cent in February, with the market estimating another benign reading for March.

India's economy is seen growing at a four-year low of 6.5 per cent in the current fiscal year ending March with growth predicted in the 6.3-6.8 per cent range next year.