There are several factors which could determine the outlook for interest rates in the current financial year 2011-12. Besides the overall outlook, it is visualised that the pattern and structure of interest rates in different market segments will come under the influence of certain changes in policy environment.

First is the likelihood of further policy rate revisions upward. Second is the borrowing programme of the Central and State governments. Third is the possible change in monetary operating procedures, if the central bank implements the recommendations of the recent Mohanty Working Group. Finally, the likely impact of the change over from the earlier system of benchmark prime lending rate to the base rate since July 2010.

Policy Rates

The most significant factor determining the outlook for interest rates is policy rates. The policy guidance indicated by the RBI in its March 17 statement makes it clear that the current anti-inflationary stance of policy will continue. The current tightening phase is, therefore, likely to prolong , given that the wholesale price inflation is ruling at much higher level than any time since 2001.

The RBI itself revising its inflation projection to 8 per cent for the fiscal year ending March 2011, and the downside risks to inflation emerging from global factors such as increasing oil and commodity prices, further policy rate hikes, at least up to about another 50 basis points, is likely within the next six months.

The easing phase of policy may not be expected till about the next busy season, that is, October 2011 or even later. Hence, the overall influence of policy on the high interest rate scenario is likely to continue up to end of calendar year 2011.

Borrowing Programme

The gross government borrowing is set at Rs 4.17 lakh crore for 2011-12 against Rs 4.37 lakh crore raised in 2010-11. The calendar of programme for the first half of the year also is moderate at Rs 2.50 lakh crore. While the borrowing programme of State governments is not known, given the budgetary trends, the increase of this component may also fall in line with Centre's programme. While the size of the borrowing programme will have a moderating influence on interest rates, which is already evident in respect of long-term government securities yields, the share of market borrowing in total liabilities is on the increase, both in respect of Central and State governments. Between March end 2007 and March-end 2011, the share of market loans rose from 19.6 per cent to 35.6 per cent in respect of States; with regard to the Centre, it went up from 64.9 per cent to 72.8 per cent during the same period and further to 75.4 per cent for the budget year ending March 2012.

While this change in pattern, emerging out of the Finance Commission recommendations, could put pressure on government securities yields, as the total liabilities of both governments in relation to GDP are declining and governments seem to be committed to fiscal consolidation, this factor may not considerably add to pressure on government securities yields.

BPLR was not responsive to policy rate changes, perhaps because of its defining features. Banks were able to operate lending rates both above and below BPLR and, hence, the BPLR remained both upward and downward sticky, not adequately capturing the policy changes.

However, it is clearly evident that in the current tightening cycle, the base rate since its operation from July 2010 has been very responsive to policy rate hikes. The base rate has shifted upward since July 2010 both in respect of public sector and private banks. In the case of the former, the range of base rates moved up from 7.5 to 8.25 per cent in July 2010 to 8.25 to 9.5 per cent in March 2011 and in the latter's case, from 7 to 8.75 per cent to 7.75 to 10 per cent during the same period.

It is not clear, however, how the banks determine their base rates. According to media reports, banks seem to be using mostly short-term deposit rates, which have seen unprecedented hikes in the recent past along with base rates. While liquidity easing due to increased release of government's cash balances in the coming months and revival in deposit growth in the banking system may ease the situation, overall, both deposit rates and lending rates are likely to remain at elevated levels during 2011-12.

Greater Transparency

Transparency can be enhanced to guide market expectations by certain additional measures. First, a calendar of State governments' borrowing programme can be announced. Second, a clear roadmap for implementation of the Mohanty working group recommendations can be laid out. Third, banks should be instructed to place their methodologies for determination of base rates in public domain. Fourth, the RBI should resume its practice of placing on its Web site, the actual lending rates of banks on a quarterly basis.

(The author is Director, EPW Research Foundation. The views are personal. >blfeedback@thehindu.co.in )

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