Onion prices propel swap gap to two-year high

The 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 (RBI’s) repurchase rate widened to 90 basis points from 57 on November 30. The spread was at 73 basis points, or 0.73 percentage point, on November 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 December 30. “They are clearly behind the curve.”

The price of onions, a key ingredient in the country’s curries and snack foods, soared 40 per cent in the week ended December 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 per cent, compared with a 113 basis point increase in China, a 161 basis point advance in Brazil and a drop of 205 in Russia.

RBI 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 per cent at the next review January 25, the highest level since December 2008, according to 11 of 16 economists in a Bloomberg survey on December 15. The rest expect no change.

Milk, fruit
An index measuring wholesale prices of agriculture products including lentils, rice and vegetables jumped 14.44 per cent in the week ended December. 18, a two-month high, government figures showed on December 30. Food makes up about 14 per cent 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 December 22.

“The fluctuation in milk, fruit, vegetables and certain commodities have contributed to inflation,” Finance Minister Pranab Mukherjee said in New Delhi December 30, when he raised his target for wholesale-price inflation to about 6.5 per cent by March 31, from 6 per cent. RBI said in a December 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’

RBI needs to keep a balance between curbing price increases and making sure the economy has enough money to grow. The Reserve Bank pumped almost Rs 41,400 crore ($9.3 billion) into the financial system in December by buying sovereign bonds to help ease the worst cash crunch in 10 years.

RBI Governor Duvvuri Subbarao said December 9 he’s “deeply conscious” of the cash shortfall, which was aggravated as companies raised a record Rs 1.16 lakh crore last year by selling shares.

RBI bought back Rs 11,502 crore of government notes December 29. Banks borrowed an average Rs 91,800 crore last quarter using the repurchase auction window, compared with Rs 23,900 crore 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 per cent bond due in May 2020 fell four basis points to 7.91 per cent, according to the central bank’s trading system. It climbed four basis points to 7.95 per cent today. The 10-year bond yield rose 32 basis points in 2010 as the central bank boosted interest rates six times to dampen inflation.