The Hindu Business Line : Rates should take a breather for now

TAKING a call on the interest rate outlook for 2005 looks very difficult. There does not seem to be much clarity on the overall trend in the medium term.

The economic data that has been coming out is pretty strong. A brief look at the table conveys that the manufacturing sector has been doing extremely well. The capital goods sector has been growing at double digits for the last three years. Credit growth (which has been adjusted for the conversions of ICICI and IDBI) has grown at a stupendous pace this year; it has grown almost four times over last year.

The growth in credit and capital goods point towards the emergence of a capex cycle. In the US, the Fed at this point seems hell bent on not stopping before the rate reaches 3 per cent.

These factors seem to suggest that the overall interest rate outlook in the medium term continues to be negative. There are no signs of the economy slowing down.

If credit continues to expand the way it has this year, then the Government's bunched up borrowings in the start of the next financial year is sure to push up rates then. But we may have a breather till then.

Manufacturing price inflation has not grown at all in the last three months. It had grown by 3.6 per cent last year in the same period. Looking at the table, one can say with some confidence that inflation for now is not a threat. It can again start moving up if the economy continues to grow at a significant pace, but for now it looks contained. Even the RBI Governor feels that it should moderate and hover around 6.50 per cent by March. If there are no significant jumps in the index, in four weeks the headline WPI inflation number should fall below 6.50 per cent. International crude prices had almost collapsed some time ago but they have started to firm up again. If they stabilise around these levels, we could even see the Government cut domestic fuel prices, which would further push inflation lower.

The Government's reliance on market borrowing to fund its fiscal deficit has fallen quite sharply this year. In spite of borrowing a meagre Rs 47,424 crore (it includes the States borrowings for debt swaps), it is running a cash surplus of around Rs 20,000 crore. Advance tax receipts could push this surplus to close to Rs 50,000 crore. Although the interest outgo on special deposits, grants to States and its regular expenditure will bring its surplus down, it looks unlikely the Government will borrow any significant sum from the market this financial.

For some reason, States have been flush with funds this year; they have been large investors in 14 days intermediate T-bills. The last WSS showed their investments in these bills to the tune of Rs 14,700 crore which tells that a large proportion of the Centre's cash surplus is on account of this.

Although I haven't seen the latest small savings collection numbers, I expect it to be significantly higher than last year.

The `recovery of loans' of the Central Government in April-October is close to Rs 38,000 crore in spite of States borrowing only Rs 14,000 crore under debt swaps.

They were supposed to transfer 40 per cent of their net small savings collections to the Centre this year under the debt swap scheme.

Clearly, the small savers are funding the fiscal deficits of the Centre and the States in a significant way and hence their limited reliance on the market for funds. Under these circumstances, incremental market borrowing this financial should be small.

The rupee has strengthened over the last couple of moths on the back of large FII flows. If international crude prices remain stable, it could strengthen further. The rupee strength should be another positive of domestic rates. Looking at Dr Reddy's remarks a few days back, one gets a sense that the central bank is unlikely to raise rates before its April policy, if at all. Hence in the current circumstances, the interest rate outlook for the short term (i.e., next two months) looks positive.

However, the medium term outlook continues to be murky.

(The author is senior trader, Interest Rates at HSBC Mumbai. The views expressed herein are his own and not necessarily those of his employer.)