In case the reader thinks that this is pure delirium, just check out the table. The differential between the yields on 10-year US and Indian gilt has dropped from the 500 basis points region to a mere 250 bps as at the end of January 2002. Through the nineties, the average depreciation in the rupee against the dollar was in excess of 5 per cent. The difference in wholesale or producer price inflation continues to be in excess of 300 bps, indicative of further depreciation in the future. With a prospective 4 per cent annual rate of depreciation in the near term, India is a cheaper source of term funds than the US, as matters stand currently. Whether India has a comparative advantage in labour costs or in manufacturing or even in back-office services or not, it is certain that she has an advantage in cost of funds, even before adjustment for credit quality. Surely, any patriotic but intelligent investor would prefer US government bonds, in comparison to its desi equivalent, when the former is at a discount Remember, the yield on US securities is the nominal yield plus the rate at which the rupee depreciates vis-a-vis the US dollar.
The powers that be are reported to be poised to enhance the countrys competitive advantage furtherby cutting some administered rates. Please note how heavy were the odds standing in the path of this major endeavour: A combined government deficit in excess of 11 per cent of GDP, where the rate of private savings in financial assets was only 15 per cent! It is unfortunate that competitive advantage in steel, chemicals, engineering etc cannot be similarly created by fiat. This bizarre state of affairs is of course quite in character with the exotic visions of a mysterious Orient. But dreams do endas they did for the purveyors of wildly antiquated made in India cars and consumer durables, after 1991. The present dream is enabled by restricting savers to rupee financial assets and is coloured by two great misconceptions.
One, that interest rates the world over have plummeted. Well they have but only for short-term money. The softening for medium and long-term bonds has been modest, as the comparison to US yields in the table clearly shows. In the Euro area, 10-year bond yields have dropped from 5.3 per cent in May 2001 to 4.9 per cent currently, while average bank lending rates to enterprises have fallen by 70 bps during the same period. Two, the present low rates of inflation at home are generally seen in isolationalways a dangerous business. Wholesale price inflation has been in negative territory both in the US and Europe ever since October 2001. The depressed state of world commodity prices has had a predictable impact on the wholesale prices of tradeable goods in India. But when the West recovers, so will these prices. As we tend to neutralise wholesale price differentials in the exchange rate of the rupee, the inter-face between domestic tradeable and non-tradeable prices is likely to get more out of sync. So, as long as choice is absent, the saver has little alternative but to invest in rupee assets, with some responding to the incentive to park funds in gold or land. The envelope can however be pushed just this much. As and when short term rates overseas move north, as they surely will, the artifice of the interest rate structure at home can come under serious pressureand the adjustment will be painful.
Saumitra Chaudhuri is economic advisor to ICRA (Investment Information and Credit Rating Agency) and editor of Money and Finance, the ICRA bulletin