Rising interest rates

Short-term interest rates are on their way up. The Reserve Bank's sharp increase in the cut-off yield on 14-day and 91-day T-bills is a clear signal that it is comfortable with higher short-end rates. The central bank is concerned that the inflow on account of the sale of Resurgent India Bonds has led to money supply growth at well above the 15 to 15.5 per cent projected rate for the year, and is likely to be above the long-run average rate of 17.2 per cent. Additionally, inflation has been rising very fast, particularly if the consumer price index is taken as the benchmark. The consumer price index for urban non-manual employees went up 13.1 per cent in July. Hence the decision to avoid any further devolvements on the central bank, a decision which avoids increasing the supply of high-powered money, but also necessarily means allowing interest rates in primary offerings to rise. With the repo rate at 8 per cent, higher yields on T-bills were called for. Yields at the 91-day T-bill auctions have now risenfrom 6.22 per cent in October last year to 9.99 per cent. Higher short-term rates also have the merit, from the RBI's point of view, of discouraging speculation against the rupee.

Luckily for the RBI, long-term lending rates to corporates have not been affected. This is the result of sluggishness in the economy. Banks are flush with funds, and unless credit picks up, long-term interest rates may not be affected. However, while the yield curve is now flatter, there are signs that the long-end too has not been entirely untouched. The yield-to- maturity for the five-year paper has risen from 11.10 per cent in April to 11.78 per cent in the primary auctions. Containing the fiscal deficit will be crucial, and unless the government can meet its deficit target, long-term rates too will head north.

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