Buy that bond now, interest rates may be peaking

Written by Aparna Iyer | Mumbai | Updated: Mar 19 2014, 11:01am hrs
Interest rates in the economy might finally be peaking as prices cool at both a retail and wholesale level giving the Reserve Bank of India (RBI) room to hold policy rates from here on.

Aditya Puri, MD and chief executive officer, HDFC Bank, says it is likely that rates should stay stable for the remainder of the year unless there is a major shock or inflationary expectations go awry. I should think rates have peaked because inflation is going down. The governor has clearly said he will balance inflation and growth, Puri said.

Siddarth Sanyal, chief economist at Barclays Capital, believes that over a slightly longer term, say, six months or a year, much will depend on the new government. But we are biased towards not expecting interest rates to go up further, Sanyal said.

With the RBI tightening policy rates, base rates of most banks have risen over the past year and are now between 10.25% and 10.50%. For State Bank of India, HDFC Bank and ICICI Bank, the base rate is 10%. The governments borrowing cost at the shorter end has risen by 100 basis points to around 9%.

At present, the best rated corporate borrowers can get short-term money through commercial paper (CP) or working capital loans at an interest rate of 10.5% and above, at least 100 basis points higher than what they were paying a year ago. Long-term funding costs have also risen by a similar margin. For instance, LIC Housing Finance raised funds through five-year bonds at 9.63% last month whereas a year earlier, the company was able to raise money at just 9.11% for the same tenure. The sharp rise in rates has kept many private companies from hitting the bond market. Companies such as Cox & Kings, rated AA-, are paying 11.75% for five-year bonds, which is higher than the 11% or so a year ago.

The RBI will detail its monetary policy review on April 1 and most economists expect it to keep the repo rate unchanged at 8% and believe the probability of further rate hikes is minimal in the short term. Thats because CPI inflation eased for third straight month to a 25-month low of 8.10% in February while at the wholesale level inflation dipped to a nine-month low.

In January, RBI governor Raghuram Rajan had said that further rate hikes may not be warranted in the short term if retail inflation follows the central banks expected trajectory and eases to 8%. Since he took charge as the RBI governor in September 2013, Rajan has hiked the repo rate three times in addition to a series of measures on the liquidity front citing inflationary pressures.

Bankers feel that even though the RBI may keep liquidity in deficit, the price of money may cool off after March. The current sharp of the curve is skewed by the March effect and once we cross over March there would be a fresh assessment of liquidity, said Hitendra Dave, head of global markets at HSBC Bank.

An improvement in liquidity and a benign inflation situation may also reduce the need for banks to hike deposit rates, thereby providing relief on cost of funds.