Mumbai: One of the most traded segments of Indian overnight indexed swap rates is near its highest level in nine months as a domestic inflation surge in July and a sharp rise in US bond yields point to tighter monetary conditions.
Overnight indexed swaps (OIS) are fixed-income derivatives that signal the future course of interest rates and are the principal tool for hedging interest rate risk in India.
Expectations of the cost of funds in the domestic banking system staying elevated have also driven up swap rates, particularly those of shorter tenures.
On Thursday, the five-year OIS rate jumped 16 basis points to close at 6.75%, its highest level since November 9. The one-year OIS rate rose past the 7% mark for the first time in five months, settling 10 bps higher at 7.04%. The one-year and five-year OIS rates are amongst the most liquid in the swap market.
While swap rates eased around 5 bps on Friday, at their current levels, they technically reflect expectations of a rate hike by the Reserve Bank of India, traders said. However, given that the alarming rise in headline Consumer Price Index inflation in July was largely driven by a likely transient food price shock, the central bank is not seen raising benchmark policy rates.
Rather, the RBI is seen keeping a tight leash on banking system liquidity and hence ensuring that money market rates remain towards the higher end of the central bank’s interest rate corridor.
“The way to interpret the (OIS) pricing is that there is reasonable clarity that liquidity conditions may continue to tighten,” Abhishek Upadhyay, senior economist, ICICI Securities Primary Dealership said.
In its policy statement on August 10, the RBI announced an incremental cash reserve ratio of 10% for banks on the rise in deposits from May 19 to July 28, a move that is seen as impounding around ₹1.1 lakh crore worth of funds.
“US yields have also risen quite sharply. Our CPI was not positive but overall details were quite good and that offset the negative headline number. So, it is a neutral domestic backdrop against a negative global outlook,” said Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership.
Higher US bond yields reduce the appeal of domestic assets for global investors, potentially causing outflows of capital and posing a risk to the stability of the rupee.
SHORT-TERM WORRY
The view of banking system liquidity remaining tight and niggling fears of more monetary tightening following the inflation shock in July has also driven up short-term government bond yields. Data released on August 14 showed that CPI inflation was at a 15-month high of 7.44% in July, well past the RBI’s tolerance band of 2-6%. The central bank’s target for CPI inflation is 4%.
Since the release of the data, the yield on the one-year government bond has risen by 10 basis points. Yields on short-term instruments such as the government’s Treasury Bills as well as debt instruments used by banks and other corporates to raise funds have also hardened.
In the latest auction of Treasury Bills on August 17, yields on the 91-day and 182-day securities were set 13 bps higher each than the previous week’s auction while that on the 364-day security was set 11 bps higher.
