Govt borrowings might exert upward pressure on interest rates

MUMBAI: While inflation has come down in the last one month, yields on government securities have gone up. Inflation, as measured by wholesale price index (WPI), has come down to 0.31% as per the latest data.

The yield on 10-year, zero coupon G-sec has increased by 60 basis points in last one month. The yield is indicative of future interest rates. And if one goes by the government announcements, wherein it has hiked the borrowing target, the yield on G-secs is likely to move up in next few months.

Moreover, the premium for maturity is much higher today than a month back. This means that the differential between the yield on a shorter-term and longer-term government debt is higher today than a month ago. Unlike earlier, it is not that only short term papers have seen yields rising due to uncertainty.

Perhaps this rise is more secular and therefore today���s yield gives a much better picture of our economy, where keeping the interest rates low by rate cuts would not longer be possible.

Banks have to be extra careful in case they are planning to increase exposure to G-sec. Typically, when credit growth slows down, banks increase investment in G-secs if they expect interest rates to remain on declining trend.

In an uncertain environment like this, it is possible that banks will have to incur mark-to-market losses in the event of yield rising. If yields do not come down further, it is unlikely that banks will cut down lending rates dramatically. And in such a case, the credit growth will not rebound, making the outlook for banks even grimmer.

By ET Intelligence Group