Mumbai: India’s interest-rate swaps show investors are bracing for Reserve Bank of India’s (RBI) measures that may require banks to hold more money in reserve as policymakers seek to cool inflation from a 13-month high, ICICI Securities Ltd has said.
The cost of swaps due in one to five years rose the most in eight months on 28 March as banks bought them to guard against an increase in short-term borrowing costs caused by RBI’s actions to drain cash from the financial system, said Arvind Sampath, senior vice-president at the unit of India’s biggest lender by market value.
The contracts show policymakers may raise the cash-reserve ratio as high as 8% at their next meeting, the most since May 2001. “What’s getting priced into swaps is an escalation in short-term rates that would follow an increase in the cash reserve ratio,” Sampath said. “Inflation is fueled by supply side factors, which can’t be addressed by using interest rates directly. The central bank is more likely to resort to liquidity tightening.”
RBI last raised the cash reserve ratio on 10 November, when it increased it half a percentage point to 7.5%. It was at 5.25% at the start of last year.
An interest-rate swap is an exchange of interest payments on a specific principal amount, usually between two parties. Also, on a payment date, it is normally the case that only the difference between the two payment amounts is turned over to the party that is entitled to it, as opposed to exchanging the full interest amounts. Thus, an interest-rate swap usually involves very little cash outlay.
Swaps are derivative contracts used to hedge against rate fluctuations and involve the exchange of floating-rate and fixed-rate payments.
The cost of swaps due in one and two years climbed 22 basis points and 21 basis points, respectively, on 28 March, the biggest advances since July, according to Bloomberg data. Five-year swap rates rose 14 basis points, also the most in eight months. One-, two- and five-year swaps were at 7.09%, 7.02% and 7.20%, respectively, on Wednesday in Mumbai.
“Bigger increases in short-dated swap rates show the market is betting on money-draining measures that will make short-term borrowings costlier,” he said.