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Interest rates on the rise?

Jun 14, 2000

Although the Reserve Bank of India (RBI) has even to hint at higher interest rates, the possibility of such a scenario does not look far-fetched. Why should the RBI consider raising rates when the economy is just recovering from a slowdown and there is ample unutilized capacity in most industries?

There are a couple of reasons for this. First is the runaway inflation rate. Another reason that could be attributed in favour of a rate hike is the decrease in interest rate differentials between India and US. With the Fed expected to hike rates in its forthcoming meeting, the differential would be further reduced, thus making the Rupee unattractive. Indeed, there has been a persistent depreciation in value of the Rupee to Rs 44.92 (down 2.9% in the last six weeks) (the depreciation can also be attributed to reasons like higher oil import bill).

The signals that interest rates may be on the rise are highlighted by the fact that the last two debt issues of the government devolved on the RBI. Potential investors were definitely looking for better yields in view of the rising inflation (which leads to lower real returns and therefore makes the instrument unattractive).

Higher interest rates have a number of implications for investors, potential finance seekers and also those that have taken loans. For investors higher interest rates would imply lower corporate profitability (as interest costs rise) and a higher opportunity cost of investing in markets. They would thus expect a higher return from their equity investments, which could result in lower stock prices.

Finance seekers, if able to pick up 'fixed rate' loans before the rate hike is effected, would be saved the extra servicing burden. Also, if inflation were to continue to rise, they would benefit as their repayment costs in current Rupees would be reduced. People who have taken fixed rate loans would also benefit in a similar manner. On the other hand people who have taken loans, with step up facility or floating rates, would stand to lose, as servicing costs would rise, commensurate with interest rates.

The talk of an interest rate hike may be considered premature by some. Nevertheless the interest rate scenario requires a re-look at this point of time. Who knows, but maybe this is the right time to reassess your investment and loan portfolio?

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