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By Kartik Goyal - Dec 15, 2010 12:02 AM GMT+0530

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India’s central bank will probably resume Asia’s fastest round of interest-rate increases next
month, after pausing tomorrow, on signs money-market traders are bracing for a revival in
inflation.

The difference between one-year interest-rate swaps and the benchmark repurchase rate
doubled to a six-week high of 73 basis points yesterday from 35.5 basis points when India last
lifted rates on Nov. 2. The Reserve Bank of India may raise the repurchase rate to 6.5 percent
from 6.25 percent on Jan. 25 after keeping it unchanged at noon tomorrow, according to 11 of
16 economists in Bloomberg News survey. Only three of 15 polled last week saw a January
move.

Governor Duvvuri Subbarao, who has boosted the repurchase rate by 1.5 percentage point in
2010, the most in Asia, needs to gain control over costs in a nation where 828 million people
live on less than $2 a day. While a report yesterday showed wholesale-price inflation slowed
to an 11-month low of 7.48 percent in November from 8.58 percent in October, the rate is still
higher than the 5.1 percent in China and 5.6 percent in Brazil.

“The central bank isn’t done yet with rate tightening,” said Rajeev Malik, a senior economist
at CLSA Asia Pacific Markets. “The RBI will come back in January and hike rates to contain
inflation.”

Swap Rates Market Snapshot

U.S. Europe Asia

The one-year swap rate, the fixed cost to receive a floating interest rate, advanced 36 basis DOW 11481.70 +53.09 (0.46%)
points, or 0.36 percentage point, since Nov. 2 to 6.96 percent, data compiled by Bloomberg
S&P 500 1242.71 +2.25 (0.18%)
show. The similar rate in China climbed 75 basis points in that period to 3.12 percent, while
Russia’s rose 47 basis points to 5.20 and Brazil’s climbed 62 basis points to 11.84 percent. NASDAQ 2630.08 +5.17 (0.20%)
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Swaps Doubling Show Traders See January Rate Rise: India Credit - Bl... http://www.bloomberg.com/news/2010-12-14/swaps-doubling-show-trad...

Poddar, Mumbai-based economist at Goldman Sachs Group Inc., wrote in a note on Dec. 2. Advertisements

“Core inflation will move sequentially higher due to increasing domestic demand and rising
asset and commodity prices.”

Inflation may average 6 percent in the year starting April 1, said Poddar, who predicted 1
percentage point in rate increases by December 2011, more than his previous forecast of Sponsored Links

between 50 basis points and 75 basis points.

The worst cash crunch in 10 years may prompt the central bank to hold off on interest rates
for another month as it buys government securities to alleviate fund shortages, Ashutosh
Datar, a strategist at IIFL Ltd., a Mumbai-based Indian brokerage.

“The RBI may pause in December to assess the impact of the previous rate moves and because
of the cash crunch,” said Datar. Even so, “inflation pressures are building up strongly,” he
said.

Yields Drop

The yield on India’s benchmark 2020 security has dropped 12 basis points from a 26-month
high of 8.21 percent in the past week as the Reserve Bank bought back 101 billion rupees
($2.2 billion) of securities. The yield fell 2 basis points to 8.09 percent yesterday.

Overnight loan rates between banks averaged 6.6 percent this month, compared with 3.3
percent a year ago. Banks borrowed an average 816.4 billion rupees a day this quarter using
the Reserve Bank’s repurchase auction window, compared with 239 billion rupees in the
previous three months, according to data compiled by Bloomberg, indicating a shortage of
money.

Deputy Governor Subir Gokarn told reporters in Kolkata last week that the move to replenish
funds isn’t a sign of a change in monetary policy.

The rupee, which has appreciated 3.5 percent this year, strengthened 0.4 percent yesterday to
44.95 per dollar, according to data compiled by Bloomberg. The currency advanced as foreign
funds poured a record $9.6 billion into rupee debt, driving the Bombay Stock Exchange’s
Sensitive Index up by 13 percent.

Rate Differential

While the RBI’s repurchase rate is 6.25 percent, the U.S. Federal Reserve’s target for overnight
interbank loans is zero to 0.25 percent, where it has been since December 2008. As a result,
the spread between India’s debt due in a decade and 10- year Treasuries, since the South
Asian nation’s first rate increase on March 19, has widened 68 basis points to 480 yesterday.
The gap, which has averaged 317 in the past decade, reached a decade high of 567 on Oct. 20.

“A widening interest-rate differential coupled with the relatively open stance toward capital
inflows points to further rupee appreciation,” said Vishnu Varathan, Singapore-based
economist at Capital Economics Ltd. Varathan last week forecast a quarter-point increase in
the repurchase rate in January from an earlier prediction of no change. He said the rupee may
gain to 42 against the dollar by the end of 2011.

Local-currency debt returned 4.4 percent in 2010, according to indexes compiled by HSBC
Holdings Plc, as the Reserve Bank tightened its monetary policy. Investors in China earned
1.5 percent, the least in the region, the indexes show.

State Bank Debt

Prices of five-year credit-default swaps used to protect against losses on the debt of India’s
largest lenders fell in the past three months, according to data provider CMA. Swap prices

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dropped 20 basis points for State Bank of India, the nation’s largest lender, and 22 basis
points for ICICI Bank Ltd., the country’s second-biggest lender. The swaps are used to protect
against missed debt payments.

Price pressures in India may also emerge from Prime Minister Manmohan Singh’s plan to
raise diesel prices and cut subsidy to state refiners including Indian Oil Corp. that sell fuel
below costs. The government partly compensates refiners for their losses, which increase as
crude prices rise.

Crude in New York trading reached $90.76 a barrel on Dec. 7, the highest level since Oct. 8,
2008. Oil has gained 12 percent this year. India, which imports three-quarters of its crude oil
needs, is working on a plan to boost diesel prices, Petroleum Minister Murli Deora said Dec.
13.

“Inflation is a big worry,” said Suvodeep Rakshit, an economist at Kotak Securities Ltd in
Mumbai. “A rate hike seems to be on the cards in January given the risks to inflation from
growth and rising commodity prices.”

To contact the reporter on this story: Kartik Goyal in New Delhi at kgoyal@bloomberg.net

To contact the editor responsible for this story: Chris Anstey at canstey@bloomberg.net

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