There have been occasions during a rising interest rate scenario when 'special' market repo rates have crashed to near zero, completely out of alignment with the monetary policy stance and imparting vortexes of volatility that obscure efficient price discovery. The impact of heterogenous expectations is also evident in the overnight index swap (OIS) market, which sits at the confluence of money and G-sec markets.
Our experience has been that the OIS market tends to overshoot. Since the OIS curve acts as the primary instrument for hedging interest rate risk in India, such front-running can distort transmission and unsettle expectations. Moreover, the OIS market is liquid only in select tenors and liquidity dries up beyond 5 years. Consequently, hedging of longterm interest rate risk becomes difficult.