* OIS curve shows Indian rate cuts this month unlikely
* RBI may opt to ease cash conditions via debt buybacks
* OIS inversion may touch 100 bps if RBI stays on hold
By Swati Bhat
MUMBAI, Oct 12 (Reuters) - As pressure builds on India's
central bank to ease monetary policy after a slew of fiscal and
economic reforms, the debt market is cautiously positioning for
policy rates to be cut, but remains unconvinced that it will
happen this month.
Asia's third largest economy is mired in its worst phase of
stagnation since the global economic crisis three years ago, and
industrialists and politicians have beseeched the Reserve Bank
of India to cut rates.
The RBI holds its next quarterly policy review on Oct. 30,
and many economists believe it will keep its policy repo rate
unchanged at 8.0 percent, due to concerns over an inflation rate
that is the highest among major Asian economies.
Since last month, the government's reforms, including a hike
in diesel prices and allowing more foreign direct investment in
the aviation and retail sectors, have helped lift some of the
gloom in Indian markets.
Equities rallied and the Indian rupee firmed
sharply. And the overnight indexed swap (OIS) curve, the curve
widely used to bet on interest rate moves, has also turned.
It used to be deeply inverted, with short term rates higher
than longer term rates, reflecting an economy where the central
bank is focused on fighting inflation despite slowing growth.
That steep inversion has been gradually unwound, with short
term rates falling.
Still the curve remains inverted, with short-term rates far
higher than longer tenors, suggesting the market is reluctant to
fully price in an October rate cut.
Few economists argue against the need for interest rate cuts
in an economy growing at its slowest in nearly three years. The
question has always been the timing, given the inflation rate.
Data due on Monday is expected to show an acceleration in
wholesale price inflation to 7.70 percent in September, the
highest this year.
Even if the data surprises on the downside, market players
would want to see a sustained trend of slower price rises.
"I do not expect a rate cut till January as inflation is the
only factor that monetary policy should be concerned about, and
inflation will go up before it comes down," said A. Prasanna,
chief economist with ICICI Securities Primary Dealership.
Other analysts agree, warning against taking the shifts in
the OIS curve as a sign that the RBI will cut rates this month.
India's OIS curve has been inverted since May 2011 as growth
prospects slowed sharply but short-end interest rates stayed
elevated due to a domestic cash squeeze and the RBI's aggressive
Investors have bet on higher interest rates in the
near-term, and lower interest rates in the longer-term, which is
unusual as swap curves are normally upward sloping, just as
other interest rate curves are, pricing in a premium for longer
The spread between one- and 5-year benchmark OIS swaps have
been negative since last year. After peaking at around 107 basis
points i n September 2011, this negative spread has narrowed to
around 60 bps, suggesting the short end of the curve is bracing
for a rate cut, though not necessarily an imminent one.
"The front end has not fully priced in a cut. If it had
priced it in, the spread would have moved to positive
territory," said Suresh Kumar Ramanathan, a forex and fixed
income strategist at CIMB in Kuala Lumpur.
Should there be any suggestion that monetary easing will be
delayed, the OIS curve is at risk of inverting further.
The 1-month OIS rate trading at 7.92 percent is marginally
below the RBI's 8.00 percent repo rate. but had it priced in
even a 25 bps cut, the OIS rate should have been closer to 7.75
"If RBI stays pat, then the curve inversion might head
towards 100 basis points from current 60 bps," Ramanathan said.
(Editing by Vidya Ranganathan and Simon Cameron-Moore)