Onion Prices Propelling Swap Gap to Two-Year High: India Credit

Onion Prices Propelling Swap Gap to High
The price of onions soared 40 percent in the week ended Dec. 18 from a year ago. Photographer: Sondeep Shankar/Bloomberg

India’s one-year interest-rate swap climbed to the highest relative to the benchmark lending rate since July 2008, as rising prices of onions and lentils increased concern policy makers may lose control over inflation.

The spread between the swap rate, the fixed cost to receive floating payments, and the Reserve Bank of India’s repurchase rate widened to 90 basis points from 57 on Nov. 30. The spread was at 73 basis points, or 0.73 percentage point, on Nov. 1, the day before the central bank last raised borrowing costs.

“The central bank will have another round of rate hikes in January to send a signal to the market that inflation is not yet under control and that the RBI means business,” Madan Sabnavis, chief economist at Care Ratings in Mumbai, said on Dec. 30. “They are clearly behind the curve.”

The price of onions, a key ingredient in the country’s curries and snack foods, soared 40 percent in the week ended Dec. 18 from a year ago and the finance ministry said the jump drove food inflation to a 10-week high. India’s one-year swaps climbed 208 basis points in 2010 to 7.14 percent, compared with a 113 basis point increase in China, a 161 basis point advance in Brazil and a drop of 205 in Russia.

India’s central bank lifted the repurchase rate by 150 basis points last year, the most of any monetary authority in Asia. The repurchase rate, at which lenders borrow from the central bank, may be raised 25 basis points to 6.5 percent at the next review Jan. 25, the highest level since December 2008, according to 11 of 16 economists in a Bloomberg survey on Dec. 15. The rest expect no change.

Milk, Fruit

An index measuring wholesale prices of agriculture products including lentils, rice and vegetables jumped 14.44 percent in the week ended Dec. 18, a two-month high, government figures showed on Dec. 30. Food makes up about 14 percent of the wholesale price index that India uses as its inflation barometer.

India placed an indefinite ban on exports of onions last month. The country eliminated import duties for the vegetable and ordered state-owned trading companies to ship supplies from overseas, Trade Secretary Rahul Khullar told reporters in New Delhi Dec. 22.

“The fluctuation in milk, fruit, vegetables and certain commodities have contributed to inflation,” Finance Minister Pranab Mukherjee said in New Delhi Dec. 30, when he raised his target for wholesale-price inflation to about 6.5 percent by March 31, from 6 percent. India’s central bank said in a Dec. 30 report that inflation is at “elevated levels.”

“Comments from RBI are clearly pointing to an upside risk to both growth and inflation,” said Sonal Varma, a Mumbai-based economist at Nomura Holdings Inc. “Rate increases will help.”

‘Deeply Conscious’

India’s central bank needs to keep a balance between curbing price increases and making sure the economy has enough money to grow. The Reserve Bank pumped almost 414 billion rupees ($9.3 billion) into the financial system in December by buying sovereign bonds to help ease the worst cash crunch in 10 years.

Reserve Bank of India Governor Duvvuri Subbarao said Dec. 9 he’s “deeply conscious” of the cash shortfall, which was aggravated as companies raised a record 1.16 trillion rupees last year by selling shares.

The Reserve Bank of India bought back 115.02 billion rupees of government notes Dec. 29. Banks borrowed an average 918 billion rupees last quarter using the repurchase auction window, compared with 239 billion rupees in the previous three months, according to data compiled by Bloomberg.

Debt Repurchase

The nation’s 10-year bonds rose last week after the central bank repurchased debt to ease the cash crunch in the banking system. The yield on the 7.8 percent bond due in May 2020 fell four basis points to 7.91 percent, according to the central bank’s trading system. It climbed four basis points to 7.95 percent today. The 10-year bond yield rose 32 basis points in 2010 as the central bank boosted interest rates six times to damp inflation. Indian sovereign bonds returned investors 5.2 percent in 2010, compared with 21 percent in Indonesia, HSBC Holdings Plc indexes show.

The cost of protecting debt of State Bank of India from default for five years rose 42 basis points to 160 in 2010, and is down from a high of 239 basis points in May after the credit outlook improved in the second half. Some investors use State Bank as a proxy for sovereign credit-default swaps.

India’s rupee rose 4.1 percent in 2010 after gaining 4.9 percent in 2009, and slumping 19 percent in 2008. The currency, which appreciated 0.6 percent Dec. 31, was little changed at 44.70 per dollar today.

Money Flows

Global money managers poured a record $29.3 billion into Indian equities last year, according to data from the Securities & Exchange Board of India. They invested $22 billion in Japan and $20 billion in South Korea. Fund inflows are poised to increase as economic growth and slowing inflation boost returns from local assets, according to Mumbai-based Yes Bank Ltd.

The central bank’s Deputy Governor Subir Gokarn said Dec. 22 that inflation risks remain and food costs aren’t dropping enough. Finance Minister Mukherjee told reporters Dec. 30 that the government is taking measures to curb prices.

“We haven’t seen food prices coming down this winter, unlike earlier years,” said Pradeep Madhav, managing director at Mumbai-based Securities Trading Corp. of India. “Rains have taken a toll on not only onions, but all other food articles.”

Inflation risks have “come to the fore,” the central bank said in a report on its website Dec. 30. The bank blamed higher food prices on rising wages and changing consumption patterns.

“The one-year swap may rise to 7.2 percent ahead of the next RBI review,” said Debendra Kumar Dash, a fixed-income trader at Development Credit Bank Ltd. “We may see a moderation in prices of food products by mid January.”

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