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Drumbeat: Ad Buzzaar
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Friday, July 3, 1998
No need for alarm
The cut-off yields at the auction of three, five, and twelve-year government paper are a signal of higher interest rates, but there does not seem to be any reason for alarm. For starters, the Reserve Bank as well as the government have in no uncertain terms said that they are in favour of low interest rates. Next, much of the government borrowing programme has been completed. Third, banks continue to be very liquid, and the RBI holds the key to further liquidity, in the shape of more cuts in the cash reserve ratio. The RBI is also not particularly bothered about taking devolvements on to its books, and the extent of monetisation is much higher than what it was last year. All these are reasons why the hike in interest rates may not amount to much. The growth of base money has been pretty moderate, and the extent of monetisation will be offset by the drying up of foreign inflows. Therefore, while the composition of base money will change, its overall levels may well remain reasonable. The presence ofsignificant excess capacity will also hold down inflation. The single most important factor pushing up interest rates is the loss of access to foreign funding, with consequent substitution of domestic funds. However, even if interest rates do go up, they are likely to have only a limited effect on corporates.Many companies have significantly improved their working capital practices in the last two years of the industrial slowdown, and the more efficient use of funds translates into lower interest outgo. Moreover, much of the increase in investment this year is likely to come in the infrastructure sector, and these are not sensitive to small changes in interest rates. Higher price increases this year too will inflate corporate bottomlines, neutralising the effect of higher interest outgo. In sum, while interest rates will increase, the impact on corporate investment will be marginal. Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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