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* 1-yr OIS rate at 7.46 pct; 5-yr OIS at 7.47 pct
* Disinversion sparked by 5-yr OIS rate surge in June
* Spread between both ends to remain narrow
By Subhadip Sircar
MUMBAI, July 5 India's swap rate curve briefly
disinverted on Friday for the first time in more than two years,
signalling the improvement of liquidity in the financial system
and expectations the central bank will not continue to cut
interest rates this year.
The 5-year overnight index swap rate rose
above the 1-year rate at one point, in what is
known in markets as a disinversion, bringing the spread more in
line with a typical situation in which longer-dated securities
should yield more than shorter-dated equivalents.
However, in India, the normalisation of the Indian swap
curve has been caused by a bear steepening trend that happens
when the longer-end is rising faster than the shorter-end.
The 5-year OIS rate has surged as investors no longer expect
the Reserve Bank of India to cut interest rates this year, given
a slump in the rupee to a record low that has revived
inflationary worries and raised concerns about the financing of
a record high current account deficit.
Although this disappointment about rate cuts has also pushed
up the 1-year OIS rate, the pace of the rise has been slower
than the 5-year after the government increased its spending in
June, helping ease tight liquidity conditions.
"The market is concerned that rupee depreciation will exert
upward pressure on inflation. So the market is unwinding its
rate cut expectations," said Nagaraj Kulkarni, rates strategist
with Standard Chartered Bank in Singapore.
India's swap curve had been inverted - an atypical situation
when the 1-year rate is higher than the 5-year - since May 2011
following a series of RBI rate hikes that raised interest rates
to as high as 8.50 percent in October 2011, while liquidity
The moves on Friday reversed that, sending the 5-year OIS
rate to as high as 7.4750 percent, above the 1-year OIS swap
rate high of 7.46 percent.
Rates at both ends surged in June as the rupee's slump to a
record low of 60.76 sharply reduced expectations the RBI will
continue to cut the country's key lending rate, or repo rate,
after lowering it by 1.25 percentage point since April 2012.
The 1-year OIS rate is now trading at 7.46 percent, well
above India's repo rate of 7.25 percent.
Rising swap rates also reflect surging U.S. Treasury yields
that have narrowed the differential with domestic yields, thus
denting the appeal of Indian debt. As a result foreign investors
have sold more than $7 billion in domestic debt since May 22.
However, the 5-year swap rate has risen far faster than the
1-year as eased liquidity conditions, which tend to most impact
near-end rates, have eased considerably.
Lenders' borrowings from the central bank have now dropped
to a nine-month low of 76.95 billion rupees ($1.28 billion) on
Friday, sharply down from 1 trillion rupees in most of May.
Eased cash conditions come as Finance Minister Palaniappan
Chidambaram has been asking government departments to speed up
spending in a bid to boost an economy that grew at the slowest
in a decade in the previous fiscal year.
Meanwhile, the RBI has also cut the cash reserve ratio - or
the amount of funds lenders must park at the central bank - by
200 percentage points since January 2012.
The eased liquidity could be positive for the economy,
allowing the RBI's rate cuts to filter through more easily
through the financial system.
The 1-year OIS was last trading up 6 bps at 7.46 percent,
while the 5-year was up 9 bps at 7.47 percent.
($1 = 60.1150 Indian rupees)
(Reporting by Subhadip Sircar; Editing by Rafael Nam & Kim