Viewed in one light, India's steeply inverted yield curve is the result of a deliberate and classic policy strategy to defend a weak currency. From another perspective, it is pointing at deep economic problems to come, possibly even recession.
Short-term interest rates in India are about 2 percentage points higher than long-term government bond yields, which makes the yield curve inverted. Typically short-term rates are lower than longer-term ones.
The swing is the intended result of the central bank's deliberate move to push short-term rates higher, squeezing speculators by making it expensive to sell the rupee.
The Reserve Bank of India (RBI) measures though are also taking a toll on the banking sector, which is heavily reliant on short-term money markets for capital. Since longer-term yields are lower - they have risen but not to the extent of short-term rates - bank lending has suffered and the value of the bonds on their books has fallen.
"There is a concern here that we have a recession in India, which could trigger further outflows," said Claudio Piron, a strategist with BofA Merrill Lynch in Singapore. The problem was that the Reserve Bank of India lacked credibility, he said.
"That's when the market thinks that you are undermining growth. And if you undermine growth, the fiscal numbers, be they corporate or government balance-sheets, will look worse and you will get more currency weakness and more outflow."
The rise in short-term interest rates, engineered by the central bank in the middle of July, has not stopped the descent of the rupee either. It hit a record low late last week of 68.85 per dollar, for a drop of 20 percent this year.
The rupee has been one of the worst affected by the turmoil in emerging markets since May, when the U.S. Federal Reserve hinted it may rein in its stimulus programme. Investors are bracing for the end of ultra-easy monetary conditions that had driven many emerging markets to record highs.
The rupee's fall has been far greater than the currencies of Brazil, Turkey, Indonesia and other countries whose vulnerability to foreign portfolio flows has made them an easy target for