Markets are signalling a sharp divergence from the Reserve Bank of India’s (RBI’s) expected policy pause on 8 April, with traders in the Overnight Index Swap (OIS) market pricing in an aggressive rate-hiking cycle over the coming months.
That divergence is feeding into the real economy. Surging crude oil prices and the war in West Asia have pushed up borrowing costs across the economy as lenders and investors factor in higher future interest rates.
The OIS market, where traders position for future interest rates, reflects expectations of the RBI’s policy path. A rise in the one-year OIS signals expectations of higher rates over the next year.
In practice, banks and bond markets use these expectations to price loans and debt, meaning a rise in rates translates into higher borrowing costs across the economy—even without an actual rate hike.
Those expectations have strengthened. The one-year OIS is now around 6.18%, well above the repo rate of 5.25%. The spread has hovered around 90-115 basis points (bps) for a month—higher than the usual 50 bps—implying anticipations of at least three rate hikes over the coming year, with each hike typically sized at 25 bps. A hundred basis points equals 1%.
“The OIS curve is showing expectations of two to three rate hikes, largely factoring in higher crude prices and rupee depreciation,” said V.R.C. Reddy, treasury head at Karur Vysya Bank.
The rupee has fallen nearly 5% since the war began on 28 February and 11% in fiscal year 2026 (FY26), hitting a record low of 95.125 per US dollar on 30 March. It currently trades at 92.92.
Suyash Choudhary, chief investment officer for fixed income at AMC, said markets have swung quickly from expecting lower rates for longer to pricing in multiple hikes, partly reflecting positioning and risk management that can push rates beyond fundamentals.
Shailendra Jhingan, treasury head at ICICI Bank, said this raises the tail risk of higher policy rates later in the year, though “this remains a probabilistic outcome rather than the base case.”
Echoes of the past
In the past, such large OIS-repo spreads have only appeared when markets believed policy rates would need to move up meaningfully. Mint’s analysis shows that since 2010, whenever markets ran this far ahead of RBI, a policy shift followed.
In 2013, during the Taper Tantrum—triggered by the US Federal Reserve’s plan to withdraw monetary stimulus—the spread exploded to 245 bps as the rupee nearly collapsed against the dollar. RBI was forced to hike rates to stabilise the currency.
In 2022, following the Russia-Ukraine war, the spread hit a 130-basis-point high as concerns of stickier inflation spiked. Again, was forced to raise rates by 50 bps just a month after an off-cycle 40 bps rate hike.
This time, the US-Israel-Iran conflict has pushed crude prices up over 60% to around $111 per barrel, raising concerns over inflation and India’s trade deficit. That has fed into expectations of a worsening macro outlook and higher rates, said Pradeep Gupta, executive director and head of India investments at Lighthouse Canton.
Some market participants also point to aggressive offshore hedge-fund positioning in the non-deliverable OIS (NDOIS) market, which is distorting domestic rates.
“Large offshore players have been aggressively pushing the one-year swap from around 5.5% levels to over 6.3% in a short span,” a senior treasury official said, requesting anonymity.
Rising yields
The bond market is signalling the same shift. When investors expect interest rates to rise, they tend to sell existing bonds that offer lower returns. As bond prices fall, their yields move up. The two-year government bond yield has risen to around 6.5%, widening its spread over the repo rate to well above 100 bps.
In effect, market rates have already tightened. Since many loans are benchmarked to these yields, companies’ borrowing costs have risen even without a policy move.
In comparison, the two-year yield spread peaked at 195 bps in 2013 and rose 132 bps ahead of the May 2022 off-cycle hike. Still, this episode is not a perfect replay.
Choudhary of Bandhan AMC noted the latest shock is not just inflationary. Higher energy prices also weigh on growth, complicating RBI’s policy response and making the outlook less straightforward than a typical tightening cycle, he said.
A 6 April Mint poll of 10 economists and market participants showed unanimous expectations of no rate change on Wednesday. However, respondents flagged rising inflation risks and a weaker growth outlook, suggesting the monetary policy committee will adopt a more cautious stance. Barclays, too, does not expect any hikes in 2026, seeing a move only towards the end of the year if oil averages around $100 per barrel.