Swaps show traders expect rate rise in Jan

The Reserve Bank of India (RBI) will probably resume Asia’s fastest round of interest-rate increases next month, after pausing tomorrow, on signs money-market traders are bracing for a revival in inflation.

The difference between one-year interest-rate swaps and the benchmark repurchase rate doubled to a six-week high of 73 basis points yesterday from 35.5 basis points, when India last lifted rates on November 2. The central bank may raise the repurchase rate to 6.5 per cent from 6.25 per cent on January 25 after keeping it unchanged at noon tomorrow.

Governor Duvvuri Subbarao, who has boosted the repurchase rate by 1.5 percentage point in 2010, the most in Asia, needs to gain control over costs. While a report yesterday showed wholesale-price inflation slowed to an 11-month low of 7.48 per cent in November from 8.58 per cent in October, the rate is still higher than the 5.1 per cent in China and 5.6 per cent in Brazil.

 

“RBI isn’t done yet with rate tightening,” said Rajeev Malik, a senior economist at CLSA Asia Pacific Markets. “RBI will come back in January and raise rates to contain inflation.”

Swap rates
The one-year swap rate, the fixed cost to receive a floating interest rate, advanced 36 basis points, or 0.36 percentage point, since November 2 to 6.96 per cent. The similar rate in China climbed 75 basis points in that period to 3.12 per cent, while Russia’s rose 47 basis points to 5.2 and Brazil’s climbed 62 basis points to 11.84 per cent.

Subbarao said last week inflation remained above the “tolerance level” of between 4-4.5 per cent. An RBI survey of price expectations of 4,000 households in urban areas showed a separate inflation index may quicken to 12.7 per cent in the next year from 12.1 per cent now, according to a December 9 statement from the central bank. A report on December 10 showed India’s industrial production rose 10.8 per cent in October, signaling consumer demand remains strong in Asia’s third-largest economy.

‘Uncomfortably high’
“Inflation may trend down gradually, but the level will remain uncomfortably high,” Tushar Poddar, Mumbai-based economist at Goldman Sachs Group Inc, wrote in a note on December 2. “Core inflation will move sequentially higher due to increasing domestic demand and rising asset and commodity prices.”

Inflation may average six per cent in the year starting April 1, said Poddar, who predicted one percentage point in rate increases by December 2011, more than his previous forecast of between 50 basis points and 75 basis points.

The worst cash crunch in 10 years may prompt the central bank to hold off on interest rates for another month, as it buys government securities to alleviate fund shortages, Ashutosh Datar, a strategist at IIFL, a Mumbai-based brokerage.

“RBI may pause in December to assess the impact of the previous rate moves and because of the cash crunch,” said Datar. Even so, “inflation pressures are building up strongly,” he said.

Yields drop
The yield on the benchmark 2020 security has dropped 12 basis points from a 26-month high of 8.21 per cent in the past week as RBI bought back Rs 10,100 crore ($2.2 billion) of securities. The yield fell two basis points to 8.09 per cent yesterday.

Overnight loan rates between banks averaged 6.6 per cent this month, compared with 3.3 per cent a year ago. Banks borrowed an average Rs 81,640 crore a day this quarter using RBI’s repurchase auction window, compared with Rs 23,900 crore in the previous three months, indicating a shortage of money.

Deputy Governor Subir Gokarn told reporters in Kolkata last week that the move to replenish funds isn’t a sign of a change in monetary policy.

The rupee, which has appreciated 3.5 per cent this year, strengthened 0.4 per cent yesterday to 44.95 per dollar. The currency advanced as foreign funds poured a record $9.6 billion into rupee debt, driving the Bombay Stock Exchange’s Sensitive Index up by 13 per cent.

Rate differential
While RBI’s repurchase rate is 6.25 per cent, the US Federal Reserve’s target for overnight interbank loans is zero to 0.25 per cent, where it has been since December 2008. As a result, the spread between India’s debt due in a decade and 10- year Treasuries, since the South Asian nation’s first rate increase on March 19, has widened 68 basis points to 480 yesterday. The gap, which has averaged 317 in the past decade, reached a decade high of 567 on October 20.

“A widening interest-rate differential coupled with the relatively open stance toward capital inflows points to further rupee appreciation,” said Vishnu Varathan, Singapore-based economist at Capital Economics. Varathan last week forecast a quarter-point increase in the repurchase rate in January from an earlier prediction of no change. He said the rupee may gain to Rs 42 against the dollar by the end of 2011.

Local-currency debt returned 4.4 per cent in 2010, according to indexes compiled by HSBC Holdings Plc, as RBI tightened its monetary policy. Investors in China earned 1.5 per cent, the least in the region, the indexes show.

SBI debt
Prices of five-year credit-default swaps used to protect against losses on the debt of the largest lenders fell in the past three months, according to data provider CMA. Swap prices dropped 20 basis points for State Bank of India (SBI), the nation’s largest lender, and 22 basis points for ICICI Bank Ltd., the country’s second-biggest lender. The swaps are used to protect against missed debt payments. Price pressures in India may also emerge from Prime Minister Manmohan Singh’s plan to raise diesel prices and cut subsidy to state refiners including Indian Oil Corp that sell fuel below costs. The government partly compensates refiners for their losses, which increase as crude prices rise.

Crude in New York trading reached $90.76 a barrel on Dec. 7, the highest level since October 8, 2008. Oil has gained 12 per cent this year. India, which imports three-quarters of its crude oil needs, is working on a plan to boost diesel prices, Petroleum Minister Murli Deora said December 13.

“Inflation is a big worry,” said Suvodeep Rakshit, an economist at Kotak Securities in Mumbai. “A rate hike seems to be on the cards in January given the risks to inflation from growth and rising commodity prices.”