After Tuesday’s monetary policy that saw a 25 basis points repo rate reduction and a host of measures to enhance liquidity in the system, the one-year overnight indexed swap (OIS) rate fell to 6.66% on Wednesday — the lowest level since November 2010.
OIS are derivative instruments used to hedge against interest rate movements. The change in OIS rates is led by the market’s perception of interest rate movement and liquidity conditions.
On Tuesday, the central bank reduced the repo rate by 25 basis points and also announced a slew of measures to enhance the liquidity in the system sending the OIS to the lowest level in more than five years. In an OIS trade, one party agrees to pay a fixed rate of interest while the counter-party agrees to pay a floating rate of interest which is based on the FBIL Overnight MIBOR rate. This is why OIS is also a function of the liquidity in the system as the MIBOR rate is affected by the overnight call money rate which in turn is a function of the existing liquidity in the system.
Participants decide to pay the fixed or the floating rate depending on their perception of future interest rates.
A party which believes interest rates are going to come down decides to pay a floating rate of interest while opting to receive a fixed rate of interest. In contrast to this, a party which believes interest rates are set to rise decides to pay the fixed rate of interest while agreeing to receive the floating rate. The transaction is based on a notional principal amount. “This is a very liquid market and is mostly driven by foreign and private sector banks. The movement in the OIS is also driven by the direction in the NDOIS,”
said a foreign banker. NDOIS is the non-deliverable OIS traded in offshore markets. On Tuesday, it had fallen to September 2010 lows of 6.55%.
It is noteworthy that of all the different OIS, the one-year and the five-year instruments are the most traded in India. In contrast to the fall in the one-year OIS, the five-year OIS rose to 6.66% on Wednesday from Friday’s low of 6.60%.