Korea, India gear for China-like tighter policy

Yields rose in swap and bond markets in South Korea, India and Indonesia on Wednesday after China's surprise policy tightening the previous day stoked expectations for similar moves and at a faster pace across Asia.

China announced a rise in banks' reserve requirement ratio by half a percentage point late on Tuesday, marking its first explicit step to tighten extremely loose monetary conditions.

It had in the past week pushed yields up at bill auctions and has gradually been withdrawing cash through repos, but the rise in the reserve ratio caught markets by surprise, pushing up onshore yuan yields.

Oil prices and stock markets slid on fears that aggressive policy tightening in China could curb economic growth and dampen demand for resources.

Yuan offshore one-year NDIRS jumped 13 basis points to 2.29% bid in early trade from Tuesday's close of 2.16%. The onshore one-year IRS jumped more than 10 bps to 2.28% bid from 2.15%.

Yuan non-deliverable forwards rose to price in a firmer future value for the dollar, reacting to worries that a tighter policy will be detrimental to the economy.

But traders also thought that was a knee-jerk reaction and betting on yuan appreciation would soon resume.

"The RRR increase will be followed by various other steps in coming weeks and months and effectively brings forward the whole tightening schedule," said Sean Callow, regional strategist, Westpac Bank.

"China cannot afford to wait for the Fed to move first and so must take the chance of substantial fresh capital inflows betting on yuan appreciation."

Ripple effect

While most markets felt some of the impact of China's announcement, it was more palpable in markets already perceived to be at the fore of the policy-tightening spree in Asia — India, South Korea and Indonesia.

India's case was also strengthened by Tuesday's data showing a pick up in industrial output and comments from a policy adviser to the government recommending the central bank tighten policy.

The three-month overnight indexed swap had climbed 10 bps from Tuesday's lows to 3.8%, although it was still 8 bps away from highs in December, when the expectations for a rise in mandatory reserves (CRR) for Indian banks were heightened.

"Given that China is now one of the leading thought setters and India and China tend to be considered a block by many, this makes the case, even if without a real basis for local CRR hike stronger," said Hitendra Dave, head of global markets at HSBC India.

In Korea, interest rate swaps edged up, although any hawkishness following China's move was tempered, with market players still wary after last week's statement from the Bank of Korea hinted at a gradual pace of policy tightening this year.

The one-year IRS edged up 3 bps to 3.48%.

"China moved earlier than expected," said Hwang Tae-yeon, a fixed-income analyst at Tong Yang Securities.

"That may help the Bank of Korea start tightening soon, as the recent data on the economy and liquidity justify its rate raise. But the political pressure is also mounting and the impact of the China's move may not be so strong."