Surge In India Swap Rates Clouds Policy Signals Amid Global Turmoil

Indian overnight indexed swap (OIS) rates have risen sharply since late February, reflecting heightened volatility in financial markets following geopolitical tensions in West Asia, although economists say the movement may be overstating expectations of interest rate increases by the Reserve Bank of India (RBI).

Since February 28, India’s one-year and two-year OIS rates have climbed by more than 45 basis points each. During the same period, the benchmark 10-year government bond yield increased by around 11 basis points through Monday before easing slightly, according to market data.

At current levels, swap markets are pricing in close to two rate hikes by the RBI over the next 12 months.

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Inflation Conditions Remain Below Target

Economists say the signal from swap markets may not reflect the current domestic inflation environment.

India’s retail inflation remains below the RBI’s 4% medium-term target, which reduces the immediate need for monetary tightening.

Suvodeep Rakshit, economist at Kotak Institutional Equities, said there is a limited likelihood of a near-term rate hike because retail fuel prices may remain stable despite higher global oil prices.

According to Rakshit, oil marketing companies and the government are likely to maintain current fuel prices, which would limit inflationary pressure in the near term.

India has also implemented emergency measures to redirect gas supplies toward households and transport fuel in response to elevated energy prices amid the ongoing conflict in West Asia.

Swap Market Movements Driven By Position Unwinding

Traders said the sharp rise in swap rates is partly linked to investors unwinding previously established positions rather than placing fresh bets on policy tightening.

Foreign investors had earlier built large “received” positions in one-year and two-year OIS contracts in anticipation of ample liquidity and stable inflation conditions.

As oil prices rose and emerging market interest rates increased globally, these positions were unwound rapidly as part of risk management strategies.

Market participants said the resulting “paying flows” in the swap market pushed OIS rates higher.

Trading activity in the swap market also increased during this period. According to market participants, average daily OIS trading volumes in the first week of March rose by about 30% compared with the average daily volumes recorded in February.

Bond Market Supported By RBI Purchases

Government bond yields have risen more gradually compared with swap rates, partly due to the RBI’s liquidity support measures.

According to market participants, the central bank has been purchasing government securities in the secondary market in recent days.

The RBI is also scheduled to buy government bonds worth about ₹1 trillion during the current week as part of its liquidity management operations.

Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership, said the sell-off in bonds has been moderated by these purchases, even as swap markets reacted more sharply to global developments.

The divergence between swap rates and bond yields highlights the influence of global market movements and position adjustments on domestic interest rate expectations during periods of financial volatility.