Interest rates should remain soft, at least for the next six months
K Ramanathan
Fund Manager, Birla Sunlife Mutual Fund
The lowering of interest rates on small savings and the announcement to revise interest rates on RBI Relief and Savings Bonds was immediately followed by a reduction in the repo rate (from 5.5 per cent to 5 per cent) and a reduction in the savings bank rate to 3.5 per cent.
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This series of cuts resulted in a significant rally at the bond markets with the 10-year benchmark yield coming down by around 40 bps between the pre- and post-Budget rate cuts. Corporate bonds outperformed similar maturity G-secs with spreads declining by around 30-40 bps.
Considering this significant decline what's the outlook going forward? Both the government and the RBI have reiterated their soft interest rate stance post-Budget. Clearly the Budget strives to stimulate consumption and investment-led demand to spur the nascent economic recovery.
This is evident from the impetus given to infrastructure spending (roads, ports etc. pump priming), leaving more money in the hands of the middle class individual (through tax reductions and rebates), cutting customs and excise duties (to entice consumption) and lowering of interest rates to prop up investment activity.
We expect interest rates to remain soft at least for the next six months. While we are seeing a pick-up in credit, there is still scope for improvement in capacity utilisation which would reduce the need for setting up new capacities, thereby reducing investment demand.
However, revenue growth projections in the Budget assume increased tax compliance and a significant pick-up in industrial activity. Also it assumes garnering of Rs 13200 crore from disinvestment. If these assumptions are not met there would be a significant fiscal deficit overshoot and this would be a negative for liquidity and for interest rates in FY2004.
Globally we are still not seeing any recovery in growth rates, and global interest rates are expected to be benign for at least the next six months. This is a positive for domestic interest rates. There seems to be some progress on the US-Iraq front too with Iraq agreeing to destroy missiles as per the UN's requirement. This would be another factor to watch out for. This could impact oil prices, and hence, inflation on the supply side.
Ramgopal Kundurthi
Chief Investment Officer, IL&FS Mutual Fund
The market was not expecting a small savings rate cut of more than 50 basis points. From the initial market reaction it appears that the overall bearishness is now being replaced by a degree of confidence. This confidence has been reinforced by the rather aggressive comments made by the FM and RBI's Deputy Governor subsequent to the Budget speech.
The RBI has now announced a 50 basis points cut in the repo rate and the savings bank rate. Going by RBI's previous reluctance to cut the repo rate and at a time when repo bids are zero, the move does come as a surprise. However, the debt markets have welcomed the move and the benchmark 10-year G-sec is now once again below six per cent.
Going forward it needs to be seen as to how much the earlier worries on high head-line inflation, the Iraq situation and fiscal year-end pressures will cap the rally. Volatility is expected to continue. On a fundamental basis the cut in repo rate should prompt a reduction in deposit rates and assist in moderation of forex inflows.
The fiscal deficit for 2002-03 as a percentage to GDP has gone up to 5.9 per cent (against the estimate of 5.3 per cent) mainly on account of lower GDP growth caused by agriculture. The shortfall in tax collections owing to a weak economy and additional expenditure on account of defence and drought have been compensated for by a reduction in expenditure mostly on capital account.
A reasonable containment job, in our view. The increase in budgeted deficit over revised estimates for 2002-2003 is Rs 82 billion, a modest 5.6 per cent growth. For achieving this, a growth of 12.17 per cent in tax revenues is assumed as against a growth of seven per cent in revenue expenditure and 16 per cent in capital expenditure.
It appears that the market was expecting only a 50 basis points cut in small savings rate. Since the reduction is higher than the market consensus, we expect this to be a positive for debt markets.
The inflationary potential of these measures like the fuel tax, fertiliser price changes and the impact of change in excise and customs duty needs to be studied. But prima facie, the overall growth-orientation could be inflationary.
Regarding the debt swap for states, it is not clear as to how the central government will compensate the savings that can be effected by the state governments. As far as debt markets are concerned, this seems to be negative as state governments will require additional borrowings from the market.
On the external front, the situation looks very comfortable. Thus, resorting to domestic borrowing (even if it is initially from the RBI), which is under strain to substitute external borrowing may not be an appropriate measure. One alternative that could have been explored is to repay high-cost external debt through government market borrowings abroad, in the process setting a sovereign benchmark.