INDIA MARKETS-Swap rates edge up as focus turns to govt budget

By Jeanette Rodrigues

MUMBAI, Jan 29 (Reuters) - Indian one-year swap rates edged up on Thursday after the central bank decided to absorb more cash from the banking system than expected, but the reaction was limited as it did little to clarify whether a policy rate hike was coming by April.

Bank shares recouped early losses while the rupee was little changed after the Reserve Bank of India lifted the cash reserve ratio -- the amount of funds banks must hold at the central bank -- by 75 basis points to 5.75 percent, slightly more than expected.

The RBI also raised its growth and inflation forecasts while calling on the government to roll back its borrowing, but its inflation-fighting tone did not convince market players that a increase in the reverse repo rate was a sure bet at its next quarterly policy review in April.

Overnight indexed swaps show the market is bracing for about 100 basis points of hikes in the reverse repo rate, now at 3.25 percent, over the next year.

Analysts said the RBI was playing a balancing act between trying to keep the economy's robust growth on track while beginning to tigthen loose monetary conditions, with an eye on rising inflationary pressures.

'The central bank had prepared the market so well for a 50 basis points CRR hike that in order to make an impact, they had to do more than that. I think they will now wait to see how inflation and the budget pans out,' said Atsi Sheth, chief economist at Macro-Sutra.

The government will announce its borrowing needs for the fiscal year 2010/11 in its Feb 26 budget, which could determine the RBI's next steps.

The one-year swap rate was at 4.92 percent, up 6 basis points on the day but falling back from a high of 4.97 percent struck immediately after the policy decision.

The benchmark 10-year bond yield was at 7.55 percent, flat on the day after jumping as high as 7.59 percent.

The partially convertible rupee was at 46.35 per dollar on the Reuters Dealing system, little changed from 46.40/41 before the decision and Thursday's 46.35/36.

Dealers said the rupee is broadly tracking the domestic equity market.

The benchmark SENSEX index was down 0.4 percent, outperforming broader Asia markets, after having slid as much as 1.7 percent after the policy news was released. Banks outperformed the main index, rising 1.8 percent by early afternoon on relief that policy rates were held steady, dealers said.



INFLATION VS FISCAL DEFICIT

To help finance its stimulus without adding to an already large deficit, India has planned a series of stake sales in state-run firms and an auction of its 3G wireless spectrum.

Dealers said the government would be keen that adequate liquidity was left in the system to ensure demand for its asset and stake sales. For a pipeline of planned IPOs, see

'Liquidity is traditionally tight in February and March, and with the government's divestment plans and this steeper-than-expected tightening, short-term liquidity will be significantly tighter,' said Sujan Hajra, chief economist at Anand Rathi Financial Services.

While the RBI has clearly launched a monetary tightening campaign, analysts were split on whether rates would be lifted before the April 20 policy review. Most analysts also maintained that broader liquidity is still comfortable.

In its policy review, India's central bank said monetary policy would be ineffective unless the government rolls back its record borrowing.

'I think what they are now looking for is some form of fiscal consolidation. Probably they mean that if the fiscal profligacy continues the way it is, then pressure on inflation will continue to come from the fiscal side. So monetary policy alone will not be that effective,' said Vineet Malik, head of interest rates at HSBC India.

(Additional reporting by Ami Shah and Neha D'Silva; Editing by Eric Burroughs)

(([e-mail]; Tel: [phone]; Reuters Messaging: [e-mail])) Keywords: INDIA ECONOMY/MARKETS (If you have a query or comment on this story, send an email to [e-mail]) COPYRIGHT Copyright Thomson Reuters 2010. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.