Is The Honeymoon With Low Interest Rates Over?

Big downswing unlikely

INDRANIL PAN

Associate VP, Kotak Mahindra Capital Co Ltd

The combined effect of a policy mix both, by the Reserve Bank of India (RBI) and the Government of India, and a large amount of liquidity in the domestic market built up through foreign exchange inflows led to sharp reductions in gilt yields over 2001-02 and 2002-03.

Though yields have tightened and showed a lot of volatility in February and March 2003, it resumed its downward trend in April. And the high inflation being seen now is unlikely to sustain for long as oil prices internationally have dipped, leading also to a reduction in the domestic petrol and diesel prices by around Re 1 on April 16.

 

Further, it is unlikely that 2003-04 would witness a surge in domestic demand that might lead to an increase in the manufactured price inflation.

The Indian Meteorological Department has already indicated a high probability on dismal rainfall (at 60 per cent), while the probability of near normal rainfall is at 14 per cent.

This raises fears of another year of relatively poor agricultural production, which could limit the domestic demand for industrial commodities.

On the other hand, lower agricultural production should not lead to higher foodgrains prices with stocks at the Food Corporation of India silos adequate.

Though inflation is unlikely to be a cause for concern for yield movement (likely to average at 4-4.5 per cent in 2003-04), expectations of another round of significant softening of interest rates in 2003-04 might prove to be over-optimistic. The bullishness of the last couple of years was due to robust foreign exchange inflows, which might taper off in 2003-04 with lower export growth as economies struggle to recover (and as the SARS virus fear grips the world).

Inflows through private repatriations may also have been stretched with the fears of war. Apprehensions over SARS might also impact invisible inflows through lower information technology sector and tourism incomes. The other possibility is a recovery in the US economy (the US consumer confidence index shows an improvement to 83.2 in April 2003 from a 9-year low of 77.6 in March 2003 and needs to be watched), leading to a stronger dollar versus major currencies