State Bank’s Hedges Cap Indian Borrowing Costs as Economy Slows

(Bloomberg) — India’s youngest infrastructure lender has increased hedging in the interest-rate derivatives market to such an extent that it’s helping keep a lid on funding costs in the country, an unintended benefit to a slowing economy.

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The lender’s more active presence has played a key role in causing India’s five-year overnight index swap rate, a key borrowing benchmark, to drop about six basis points to 6.25% since the recent US presidential election, swap traders say. That’s despite yields on 10-year Treasuries, which often dictate movements in Indian swaps given the dominance of foreign banks in the local market, climbing 16 basis points during the period.

The National Bank for Financing Infrastructure and Development, or NaBFID, has in recent months boosted transactions in OIS and started trading total return swaps, products to help shield it against volatility in rates, according to its managing director Rajkiran Rai G. It has been seeking to hedge against a decline in interest rates after a spate of bond issuance earlier this year.

“We have entered the OIS market and more recently the TRS market because as a financial sector institution we need to guard against interest-rate risk,” said Rai. “It is important for us to manage fixed and variable rate exposure because while our loans are of 15–to-25-year tenure, they have one-year or six-month resets.”

Swaps allow investors to protect themselves from interest-rate swings by placing opposite bets using them as a hedging tool. For example, a holder of fixed-income instruments such as government bonds can swap a pre-determined rate for a variable income stream.

The recent hedging by the state infrastructure lender, which was set up in 2021, has helped cap the upside of funding costs at a time when government officials have become increasingly concerned about India’s weakening growth. That said, the decline in rates may pose a challenge for the country’s central bank that insists its inflation battle is far from done.

While the NaBFID made its debut in the OIS market around a year ago, it has started carrying out TRS trades in the past three months, said two executives at banks which were counterparties in these transactions. The state lender has been receiving fixed rates to hedge against falling rates, a trade that exerts downward pressure on swaps, they said, asking not to be named discussing a private matter.

NaBFID’s recent swap market activity has contributed to the de-coupling of Indian swaps from US bond yields, they added.

NaBFID issued rupee bonds worth 81.91 billion rupees ($970 million) between April 1 and Sept. 30, with 50 billion rupees of the notes carrying a ten-year maturity. The rest will come due in two decades.

“We cover our positions on a portfolio basis with an average covering of around 60%-70% of the quantum of the bond issuance in the swap market,” Rai said.

–With assistance from Vrishti Beniwal.