Short-term interest rates rising, loan rates to stay low a while: experts

The low interest rate phase hasn't really helped investors or investment; Covid-19 was actually a supply side shock

For a year and a half, money market rates were tethered to their lowest ever, after the Reserve Bank of India cut the repo rate to 4 per cent and the reverse repo rate to 3.35 per cent, and started buying government debt through open market operations to enhance liquidity conditions in order to tackle the economic shock of Covid-19. 

But interest rates in the shorter term are on the rise since September-end. 

There is a very slight uptick in the rate at which banks lend to each other for immediate requirement of funds. The Mumbai Interbank Offered Rate (MIBOR) has gone up from being close to 3.8 per cent for nearly four months, to 3.86 per cent after the October meeting of RBI’s Monetary Policy Committee (MPC). This means that the overnight cost of funds for banks is now looking up. 

The 3-month T-Bill (treasury bill) yield went up from 3.27 per cent on September 13, to 3.44 per cent in the October 18 auction.

The cut-off in the October 27 auction has further gone up to 3.56 per cent. This suggests that short-term financing of the government deficit is getting slightly costlier than what it was in the pandemic to date. 

Same is the case with six-month and one-year treasury bills. After reaching a yearly high of 3.88 per cent in June 2021, the 364-day T-Bill yield had moderated.

It is looking up again, as it went up to 3.87 per cent on October 18, only to breach the 4 per cent mark in the October 27 auction. It currently stands at 4.04 per cent. 

The cut-off rate of the variable rate reverse repo (VRRR) auction has risen from 3.61 per cent at the beginning of October, to 3.99 per cent towards the end of the month. What this shows is that banks are parking money with the RBI, and are getting a much better interest rate than the reverse repo rate, which stands at 3.35 per cent: or, a higher interest rate under VRRR is slowly sucking liquidity out of the system.

This is a tidy upturn from the long phase of high liquidity and low short term interest rates that began after RBI’s measures to tackle the pandemic started bearing fruit. 

Now, low short term interest rates have resulted in lower rates of consumer loans. Housing loan interest rates have fallen to their lowest ever, at 6.5 per cent (floating rate). But it also made the interest rate on 1-year term/fixed deposits fall to 4.9 per cent. So, savers’ earnings too fell.

Will the current uptick in short term interest rates result in loans getting costlier, and deposits giving more returns, soon? Experts think that it is too early to say so, and that there are a multiplicity of factors that would determine whether borrowing rates would rise. 

MPC member Ashima Goyal said in the October meeting that long term interest rates are unlikely to move up. 

“Market expectations in current forward rates see short [term] rates rising over the next year with little change in 10-year G-secs rates. As uncertainty reduces, the inflation target is well internalised, and government borrowing requirements reduce, spreads should fall further,” note the minutes of the most recent MPC meeting. 

“Long rates are important for investment and as benchmarks for private borrowing. The yield curve is likely to flatten, although oil price uncertainty is a risk,” she added. 

The relation between long term rates in the economy with the short term market rates, and the policy rates is very complex. It is hard to pinpoint what is causing what. 

In that sense, experts think that the movement in long term rates of consumer loans, would be dependent on the rates of deposits, or the cost that banks incur to raise funds. 

“The certificate of deposit (CD) rates are pretty stable at the moment. If deposit rates go up, there could be a higher probability of borrowing rates rising,” said Ananth Narayan, senior India analyst at the Observatory Group. 

He said that the external benchmark used to arrive at lending rates is the repo rate, which is unlikely to be hiked anytime soon. “Even members who are cautious about the MPC’s accommodative stance are clear about not hiking the repo rate anytime soon,” he told Business Standard. 

Though CD rates are looking up north, they are unlikely to go up fast, due to sufficient liquidity in the system. The current slight uptick could be a result of the VRRR auctions being carried out by the RBI, which have pushed up MIBOR, T-Bill rates. 

Parag Waknis, a monetary economist who teaches at the Ambedkar University in Delhi, said that the low interest rate phase may have forced inefficient portfolio adjustments on investors, and did not do much for corporate investment. Covid-19 was a supply side shock to start with, and therefore easy credit with only limited direct transfers did not make a very effective stimulus policy , he said. 

“But it may have lowered cost of short term funds for some companies easing their working capital constraints. Through multiple simultaneous asset purchase programs RBI tried to use the excess liquidity it pumped in the system via lowered reverse repo rate to reduce cost of long term borrowings for the government but with only marginal success. Now that the recovery has begun, inflation, which is primarily pro-cyclical in India can be expected to pick up in the near future. This should prompt a correction in the lowered reverse repo rate, but MPC could do with holding off raising the policy rate for at least couple more meetings to stimulate investment spending as the economy recovers.” he told Business Standard.
 

The transmission into long-term borrowing rates on consumer and investment loans may not spring up that soon, especially since the MPC has been clear in its primary focus of supporting growth and keeping an accommodative stance. 

Market participants said that now that VRRR is being exercised more frequently and liquidity is being gradually curtailed, the operating rate in the short term money market will shift from reverse repo rate to the repo rate. “In fact that seems to be already underway,” said a market observer.  

It all then depends on when the RBI will take the call of hiking the policy repo rate. Till then, short term money market rates may see an uptick, but they will not translate into costlier loans in the economy, unless RBI changes its stance.