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Which way will interest rates go?

Jul 8, 2009

It is clear from the Union budget 2009-2010, that India's borrowing programme will gather further pace. In fact, the government plans to borrow almost Rs 4 trillion from the markets in FY10, a jump of 50% over last year. Normally, the immediate impact of a greater demand for credit is higher interest rates. However that is unlikely to happen in the short term at least, as per one of the most respected voices in finance. A leading business daily quotes Mr. Deepak Parekh, the chairman of HDFC, "There is sufficient liquidity so far in the market. I don't think it (rate) is going to harden that much at least in the next three to four months."

In fact, Mr. Parekh believes that short term interest rates are actually going to fall as the supply of credit is way above the demand for it. "I expect the rates to go down by at least 50 basis points (0.5%) over next six months", he adds.

The long term yields are another matter though. The deficit figures are likely to keep them moving upwards . However, we should also pay attention to the 'second-order effect' as Charles Munger, Vice Chairman of Berkshire Hathaway, would say.

The 'second-order effect' in this case would be what economists term as the 'crowding out effect' - the government soaking up resources (here credit) that the private sector needs. Lower disbursal of credit to the private sector would nullify the greater disbursal to the government.

Thus, things are as uncertain even in the field of fixed income as they are in the stock markets. But most likely, interest rates are likely to head up over the next few years, at least till the time the government brings its house in order by reducing its deficit.

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