India 1-Year Swaps Overstate Rate Risk, Standard Chartered Says

March 17, 2010, 10:12 PM EDT

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By V. Ramakrishnan and Anil Varma

March 18 (Bloomberg) -- India’s swap rates overstate the amount by which

the central bank will likely raise borrowing costs, providing investors an
opportunity to profit by receiving fixed payments, Standard Chartered Plc
said.

A six-fold increase this fiscal year in the spread between one-year swap
rates and the overnight call rate signals some investors are bracing for
policy rates to be raised by as much as 3 percentage points by Dec. 31,
Arvind Sampath, head of interest-rate trading in Mumbai, said in an
interview. He predicted the Reserve Bank of India will increase by no more
than 1.25 points, striking a balance between curbing inflation and
supporting an economic recovery.

Swap rates are “currently pricing in a lot of interest- rate hikes, much of
which aren’t consistent with the economic- growth the government is
projecting,” Sampath said. “Actual rate increases will probably be smaller
than what short-term swaps are suggesting, and hence it’s good to
receive.”

Investors should agree to receive fixed payments for one year in exchange
for paying an adjustable rate linked to the overnight borrowing rate between
banks, he said. The one-year swap rate is currently at 4.90 percent, while
the overnight rate is at 3.25 percent. The spread between the two rates has
averaged 1.68 percentage points this month, compared with 27 basis
points in April 2009, when the current fiscal year began.

In an interest-rate swap, two parties agree to exchange payments over a

period of time, typically involving fixed and fluctuating rates. In a so-called
overnight indexed swap, the floating payments equal the one-day money-
market rate irrespective of the maturity period of the transaction.

Policy Outlook

Montek Singh Ahluwalia, deputy chairman of India’s Planning Commission,

said March 2 that analysts at Goldman Sachs Group Inc. are likely to be
proven wrong on forecasting the nation will raise rates 3 points this year.
The central bank’s policy preference is to balance aiding growth and
capping price gains, Deputy Governor Subir Gokarn said in January.

India’s economic growth may quicken to 8.75 percent in the next fiscal year
from an estimated 7.2 percent in the year to March 2010, the Finance
Ministry said last month. Wholesale prices rose 9.89 percent from a year
earlier in February, the most since October 2008, the government said
March 15. Inflation may accelerate to double digits, RBI’s Gokarn said
March 11, adding the measure won’t “persist” at those levels.

Reserve Bank Governor Duvvuri Subbarao has kept the key reverse-
repurchase rate at 3.25 percent since April 2009, the lowest level since the
rate was introduced a decade ago. He ordered banks to keep aside a
greater proportion of deposits in government bonds in October to counter
quickening inflation. In January, he raised the amount of cash banks must
hold in reserve to 5.75 percent of deposits from 5 percent.

--Editor: Sandy Hendry, Ven Ram

RBI@IN

To contact the reporter on this story: V. Ramakrishnan in Mumbai at

rvenkatarama@bloomberg.net; Anil Varma in Mumbai at
avarma3@bloomberg.net.

To contact the editor responsible for this story: Sandy Hendry at

shendry@bloomberg.net