The one-year overnight indexed swap (OIS) rate hit close to two-year lows at 7.41% on Monday on expectations the upcoming Consumer Price Index (CPI) data, supported by falling crude oil prices, could strengthen the case for a rate cut.
The five-year OIS stood at 7.09% on Monday.
According to Ananth Narayan, regional head of financial markets, South Asia at Standard Chartered the market for overnight indexed swaps is relatively narrow and limited to a few banks and institutions in India as of now.
“Having said that, the current rate easing cycle of the RBI, with policy LAF repo rate cut down to 7.25%, and expectations of either stability or further rate cuts, has helped bring the one-year OIS rate to around 7.40%—levels not seen since mid-2013,” he said.
Narayan believes that factors such as slow credit off-take, subdued investment and consumption climate, low global commodity prices, stable and overvalued Rupee with high interest rate differentials in favour of the Rupee, low growth in rural wages and minimum support prices for agriculture make a case for continued monetary policy easing.
“Given the current trend in global commodity prices, I am hoping that inflation will trend lower than that anticipated by the RBI. This should allow for 25-50 bps of rate cuts in this fiscal year,” he said.
OIS are derivative instruments used to hedge against interest rate movements. While one party to the transaction pays a fixed rate of interest, the counter-party pays a floating rate of interest which is based on the FBIL Overnight MIBOR rate.
The parties decide to pay the fixed or the floating rate depending on their perception of future interest rates. If the view is one of rates coming down, the party would pay a floating rate since the FBIL Overnight MIBOR—the rate on which the floating rate is based—tends to move in tandem with the policy rate.
In contrast to this, a party which believes interest rates are set to rise decides to pay the fixed rate of interest.
Of all the different OIS, the one-year and the five-year instruments are the most traded in India. Interest rate swap movements typically indicate where the rates are headed but since the market is not very large, indications may not always be perfect.