Indian Central Bank Governor Says Rupee May Be Undervalued, Sovereign Bond Yields Continue to Climb

Affected by the US-Iran war that broke out in late February and the closure of the Strait of Hormuz, global crude oil prices have risen by about 45%, leading to high import costs in India and undermining investor confidence. The Indian Rupee's exchange rate against the US dollar hit a historical low of 96.96 last week. Following Trump's statement that the US-Iran agreement is "basically negotiated," Brent crude oil plunged by 4.6% to $98.8 per barrel, falling below $100 for the first time in two weeks. With central bank intervention, the Rupee closed at 95.69 last Friday, and it is expected to open around 95.50 on Monday, with a cumulative decline of 6% year-to-date.

Indian Central Bank Governor Sanjay Malhotra subsequently stated that the Rupee has been undervalued, and the central bank will "take all necessary measures" to ensure stability in the foreign exchange market. However, the Trump administration downplayed expectations of a short-term agreement on Sunday, and ING analysts warned against overreacting. Meanwhile, due to the transfer of war costs, Indian state-owned retailers welcomed the fourth increase in gasoline and diesel prices in May on Monday.

To hedge against the impact of previous dollar sales on the Rupee liquidity of the banking system, the Indian Central Bank will launch a $5 billion dollar-for-Rupee buy-sell swap auction on Tuesday. Current traders expect the Rupee exchange rate to fluctuate between 95 and 96 this week. Although most economists expect the Indian Central Bank to keep interest rates unchanged at the June 5 meeting, Standard Chartered Bank and Mitsubishi UFJ Bank have begun calling for rate hikes to manage exchange rate and inflation expectations.

At the same time, the increasing inflationary pressure has pushed India's 10-year sovereign bond yield to 7.0917% last Friday. The market has already priced in an expectation of a 125 basis point rate hike within the next year, driving swap rates to multi-year highs. This trend has attracted asset management companies such as Aditya Birla Sun Life and DSP to enter the arbitrage market. Investment institutions are heavily purchasing three-year floating-rate corporate bonds and converting them into synthetic fixed-rate investments through overnight index swaps, thereby locking in yields that are 75 to 100 basis points higher than ordinary bonds. Since mid-May, the issuance of Indian floating-rate debt has reached 64 billion Rupees.