Rajan rate bets pared in swaps as inflation climbs: India Credit

[NEW DELHI] India's interest-rates swaps show investors are scaling back bets on monetary easing after the central bank said it wants benchmark borrowing costs to stay above inflation.

The fixed payment to lock in rates for a year has jumped 18 basis points to 7.66 per cent since Feb 2, a day before the Reserve Bank of India kept the repurchase rate at 7.75 per cent. Governor Raghuram Rajan said he prefers the benchmark between 1.5 and 2 percentage points above consumer-price inflation. The CPI rate was 5.5 per cent in January, a Bloomberg survey shows before data due Thursday.

Nomura Holdings Inc and Societe Generale SA said Mr Rajan's goal of capping price gains at 6 per cent limits room for rate cuts to 25 basis points, half the reduction forecast in a separate Bloomberg survey.

While oil's plunge has lowered energy costs in India, food prices was one of the key issues that abruptly ended Prime Minister Narendra Modi's honeymoon with voters as they delivered his party a crushing defeat in the Delhi elections yesterday. Rajan, who unexpectedly eased policy on Jan 15, said missing his real-rate target risks eroding savings and forcing people to buy gold as a store of value.

"Given Rajan's preference to preserve the real policy rate at around 2 per cent and sustain savings, there is very limited space to cut rates," Kunal Kundu, an economist at Societe Generale in Bengaluru, said in a Feb 9 phone interview. "Inflation isn't likely to undershoot RBI's January 2016 target of 6 per cent by much." Three weeks after the unscheduled rate cut, Mr Rajan flagged risks on Feb 3 from uncertainty about monsoon rains, a reversal of crude oil's drop and volatility in global markets.

"Even though interest rates have to be lower for more incentives for investment, we have to keep in mind that the savers should not be forgotten," Rajan said in a Feb 4 interview with Bloomberg TV India. "That's why we need to keep interest rates commensurate with the fall in inflation rather than suddenly cut in such a way that you enhance investment, but then find savings falling off and people buying gold." Inflation, which slowed to a three-year low of 4.38 per cent in November, is set to rise for a second month as vegetable prices surge. Onions, a staple for India's 1.24 billion people, cost 36 per cent more in New Delhi at the end of January from a year earlier, while tomatoes jumped 72 per cent, official data show.

Modi's Bharatiya Janata Party was trounced in the state of Delhi by the two-year old Aam Aadmi Party, which translates to "Common Man," showing bread-and-butter issues still matter at the ballot box. The Aam Aadmi Party won 67 of 70 seats in Delhi on Tuesday after a campaign in which its leader, Arvind Kejriwal, promised cheap electricity, water and medicine.

Mr Rajan said last week the central bank will need to "carefully monitor" the surge in vegetable prices as well as the revisions in the consumer price index that will be reflected in Thursday's figures. The Statistics Ministry has said it will change the base year for weights to 2011-12 from 2004-2005 and adjusted the weighting of various costs of living to capture changes in Asia's third-largest economy.

The weightage of clothing and footwear in the inflation basket will rise to 6.53 per cent from 4.73 per cent and that of housing to 10.07 per cent from 9.77 per cent, according to the ministry. The share of food and beverages will drop to 45.86 per cent from 47.58 per cent and of fuel to 6.84 per cent from 9.5 percent.

"The RBI's status quo should be seen in the context of the impending revision in the CPI index," Gaurav Kapur, senior economist at Royal Bank of Scotland Group Plc in Mumbai, said in a Feb 9 phone interview. "The RBI would look for at least next two readings of the new monthly series, to revisit its assessment on the level of headline inflation during 2015." The Statistics Ministry said this week India's growth will accelerate this fiscal year under a revised method for calculating gross domestic product that's puzzled economists.

The economy will expand 7.4 per cent in the year through March 31, aided by a 7.5 pe rcent increase in October-December, the ministry said on Monday. Last month, it revised the previous year's expansion to 6.9 per cent from 4.7 per cent, prompting economists including Mr Rajan to question the growth surge.

The yield on India's 10-year sovereign bonds was little changed Tuesday at 7.73 per cent, while the rupee weakened 0.1 percent to 62.2050 the dollar.

Mr Rajan also said on Feb 3 that further easing in borrowing costs is contingent on the quality of fiscal consolidation. Modi has pledged to cut the budget deficit to a seven-year low of 4.1 per cent of gross domestic product in the year ending March 2015 and to 3.6 per cent the following year.

While the median forecast of 26 economists surveyed by Bloomberg from Jan 23 to Jan 28 is for the repurchase rate to be cut to 7.25 per cent by the end of 2015, Morgan Stanley predicts it will be slashed to 6.50 per cent.

"Inflation is expected to decelerate sustainably to the 5 per cent level from April in our base-case outlook," Chetan Ahya, the bank's Hong Kong-based chief Asia economist, wrote in a Feb 3 research note. That "will open up the opportunity" for an inter-meeting cut in mid-March or at the April 7 review.

BLOOMBERG