Since the close of 2000, interest rates have cruised downhill. Between January of 2001 and 2003, the yield on 10-year Government securities (G-sec) fell from 10.8 to 5.8 per cent ? a decline of 500 basis points (bps). After a hiccup in February 2003, yields on 10-yr G-sec have stabilised around 5.8 per cent. Short-term yields have also moved southwards, but by less. The yield on 91-day Treasury Bills (TB) has slid from 8.9 per cent in January 2001 to about 5 per cent presently ? a fall of 390 bps. The yield curve in the Indian treasury market has thus gone from being gently upward sloping to becoming as flat as a tabletop.

In contrast, since January 2001, the yield curve in the US treasury and corporate debt markets has gone from being flat to steeply upward sloping. Between January 2001 and now, yield on 10-yr US G-sec has edged down from 5.1 to 3.7 per cent, a fall of 140 bps, while Aaa (Moody?s seasoned pool) corporate securities have dropped from 7.1 to 5.3 per cent, a decline of 180 bps. At the shorter end of the yield curve the drop was spectacular, with yield on US 91-day TB plummeting from 5.3 to 1.1 per cent, a change of 420 bps.

What are the signals from such developments? In the US, people clearly expect that in the medium term, interest rates cannot fall by much ? as is evident if we look at the progress of the US 10-yr G-sec and Aaa corporate bond yields in the accompanying chart. The market understands that the present regime of soft rates is specific to the soggy economies of the advanced world, and the US in particular. Which is far from being a permanent state of affairs.

But what do we make of our flat yield curve? There was a time when, because of financial repression, we used to have an inverted yield curve. We still have a government with an excessively large appetite for debt, but the days of administered interest rates are over. How conjuncture-specific then are the conditions which permit this luxury of having interest rates comparable with advanced economies?

In the short term, till spring 2004, we can reasonably expect the advanced economies to continue in their present state of weak and uncertain growth. Which means that short-term rates are going to continue to be weak, acting as a drag on longer yields. The present co-ordination problems in the European Union and the difficulties of its central bank to cut rates mean that the euro is going to remain strong, further exacerbating the difficulties of revival of Eurozone economies. India has quite cleverly followed the dollar down, which gives the Reserve Bank the elbowroom of staying with soft rates. But when the US economy recovers, and hopefully so also Eurozone economies, short rates will begin their migration northwards. The present big gap between short-term rates in India and the US will not be an effective buffer. Our yield curve won?t remain flat, and we had better begin to plan for it.

The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)