The Telegraph
Since 1st March, 1999
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Bonds give banks rate-hike itch

New Delhi, June 4: Government bond rates, a barometer for bank lending rates, are headed northwards once again.

North Block officials said higher bond rates may act as a trigger for a quarter percentage point rise in bank lending rates by the end of July as well as an increase in short-term rates.

Next week, the Reserve Bank will auction for the government a five-year, 9.39 per cent stock as well as a 30-year paper, which is expected to fetch about 8.3-8.4 per cent. The nominal value of the two issues will be Rs 10,000 crore.

The rates are far higher than the 7.5 per cent yield which the 10-year bonds attracted when the RBI announced its annual credit policy in April. “This of course is simply a sign of what is happening in the economy ... rates are hardening without any announcements,” a senior analyst with HSBC said.

Over the last one year, bank lending rates have increased by 2-2.5 per cent for most borrowers. Under pressure from the finance ministry, banks have kept their prime lending rates intact but have raised it for others. (Prime lending rate is the rate that top companies pay to access funds.)

Banks have raised rates as the cost of obtaining funds has gone up. Money in fixed deposits have also been far less this fiscal compared with previous year. They have also raised the risk weights on loans, following the RBI’s mandate in this regard.

Analysts and North Block policy makers agree that there is already an unannounced credit squeeze. This could help beat the inflationary expectations which appear to be building up from the pressure of higher oil and steel prices and low food stocks with the government.

The higher coupon rate on government papers and the probable higher interest rates on deposits by end-July will have a positive impact on the economy. The moves will suck out excess money from the system.

Money supply has grown from around 16 per cent in March this year to 17.6 per cent by mid-April, propelled by higher foreign exchange reserves and rising bank credit to the commercial sector which has grown by 28.7 per cent.

But forex reserves, which increased from $143 billion in February to $163 billion by mid-May, have started declining marginally, due to withdrawals by foreign institutional investors and the rising oil import bill.

This is exerting pressure on the rupee. The Indian currency is under pressure from the huge demand for dollars in recent weeks.

It is likely that the rupee will remain under pressure as oil prices continue to simmer above the $70-a-barrel mark, while FIIs are likely to remain net sellers.

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