Thursday 3 April 2008

Swaps Show India to Raise Cash Ratio to 7-Year High, ICICI Says

India's interest-rate swaps show investors are bracing for central bank measures that may require banks to hold more money in reserve as policy makers seek to cool inflation from a 13-month high, ICICI Securities Ltd. said.
The cost of swaps due in one to five years rose the most in eight months on March 28 as banks bought them to guard against an increase in short-term borrowing costs caused by central bank 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 policy makers may raise the cash-reserve ratio as high as 8 percent at their next meeting, the most since May 2001, he said.

``What's getting priced into swaps is an escalation in short-term rates that would follow an increase in the cash reserve ratio,'' Mumbai-based Sampath said in an interview. ``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.''

The Reserve Bank of India last raised the cash reserve ratio on Nov. 10, when it increased it half a percentage point to 7.5 percent. It was at 5.25 percent at the start of last year.

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 March 28, the biggest advances since July according to data compiled by Bloomberg. Five-year swap rates rose 14 basis points, also the most in eight months. One-, two- and five-year swaps were at 7.09 percent, 7.02 percent and 7.20 percent respectively yesterday in Mumbai. A basis point is 0.01 percentage point.

Betting on Measures

``Bigger increases in short-dated swap rates show the market is betting on money-draining measures that will make short-term borrowings costlier,'' Sampath said.

Wholesale prices rose a faster-than-expected 6.68 percent in the week ended March 15 from a year earlier, the most in 13 months, the government said March 28. The inflation rate is ``unacceptably high'' and the central bank is ready to take action to contain price gains, Reserve Bank Governor Yaga Venugopal Reddy said March 31.

``Policy makers have to take steps to curb excess money in the coming weeks,'' Sampath said. ``Government spending will increase in April, boosting cash in the system. If they let the liquidity stay as it is, it will feed into inflation.''

Finance Minister Palaniappan Chidambaram plans to increase spending in the new fiscal year to spur economic growth that may have slowed for the first time since 2005. Asia's third-largest economy probably expanded 8.7 percent in the year ended March 31, according to a government forecast, compared with 9.6 percent the previous year, the fastest since 1989.

Money supply growth in India averaged 21.6 percent in the fiscal year ended March 31, above the central bank's target range of 17 percent to 17.5 percent, Reserve Bank data show.