The Hindu Business Line : Upping ante on interest rates

THE tension in the money market over the last few weeks on a "rate hike" was put to rest by the Reserve Bank of India with a repo rate hike of 25 bps while leaving the Bank Rate and the CRR untouched. The market yields yo-yo-ed in the last few days as opinion polls and vote banks spewed myriad views on the possibility of a rate hike.

On the positive side, the manufacturing sector is showing robust growth, and credit and investment demand are becoming clear. Export growth has been robust as well.

While agriculture may not meet target estimates due to monsoon shortfall, thanks to industry and services showing robust growth, GDP estimates have been revised only a shade lower at 6-6.5 per cent against the 6.5-7 per cent.

However, given the global oil price trends and commodities price increases, inflation estimates have been scaled up significantly to 6.5 per cent from 5 per cent earlier.

This will hold the key to interest rates over the next 12 months. Interestingly, the central bank while emphasising the objectives of providing adequate liquidity to meet credit and investment demand as well as maintaining price stability based on macroeconomic factors have highlighted that "they could take calibrated measures in response to evolving circumstances with a view to stabilising inflation". This clearly gives a feeling of more measures to come.

Local and global factors are likely to influence rate movements. Key factors include liquidity, inflation and credit demand offtake locally as also the global factors of oil and economic growth of key nations.

Sovereign rates have shown a firm uptrend in the last six months — 91-day T-bill from 4.29 per cent to 5.2 per cent, 364-day T-Bill from 4.57 per cent to 5.49 per cent and one-year residual maturity G-sec from 4.51 per cent to 5.51 per cent.

Even overnight call has moved from an average of 4.29 per cent to 4.57 per cent. However non-sovereign rates, whether of deposit or borrowings, have not moved in the same tandem.

Empirical evidence shows that bond markets lead the way and move faster than the other segments. So the trend seems to be firm.

Consumption-led credit demand has continued unabated, and more than two-thirds of the credit growth was accounted by this.

Clearly, the central bank seems to be concerned both from a risk perspective and asset price inflation possibility. Hence, risk weights for both housing finance (50-75 per cent) and personal loans (100-125 per cent) have been increased.

The Mid-Term Review continued to emphasise on flow of credit to priority sectors, agriculture and SSI and focus on easing credit delivery mechanisms for the same. Some measures have been introduced/eased which is welcome.

Term deposit tenor for retail deposits has been brought down to seven days.

Overall, the central bank has upped the ante on a firm trend on interest rates and growth, inflation, liquidity and global factors will determine the speed and movement of rates.

One can expect more volatility from here and further measures depending on interplay of the above factors.

(The author is Group Head, Corporate and Institutional Banking, Kotak Mahindra Bank.)