At 6.5% inflation, it pays to borrow

Rupee at a 1-year low; Gilt, bank rates turn negative.

With the wholesale price index-based inflation rate climbing to 6.52 per cent for the week ended July 9, the real interest rates on government securities across the maturity spectrum, as well as on bank deposits, have turned negative.

Meanwhile, the rupee lost almost 7-8 paise to the dollar to close at 46.32/34 -- its lowest close in a year.

It opened weak at 46.27/29 against yesterday's close of 46/26 to a dollar. Dealers said uncertainty in the government's foreign investment policy was keeping inflows at bay and creating panic among importers.

With the spurt in inflation, all gilt returns have turned negative. For instance, the yield on the ten-year benchmark 7.37 per cent 2014 paper closed at 5.96 per cent on friday, 56 basis points lower than the inflation rate. One basis point is hundredth of one percentage point.

The rise in inflation was mainly on account of a hike in the prices of oil and primary articles, analysts said.

While at the shorter end of the maturity, yields on the 91-day and 364-day treasury bills are ruling at 4.49 per cent and 4.63 per cent, respectively, and at the longer end, the return on the 13-year paper in the secondary market is 6.26 per cent.

The paper with the longest maturity "" maturing in 2028 "" is now offering an yield of 6.46 per cent, which is below the inflation rate. The return on bank deposits, in the range of 5.50-6.25 per cent at the longer end (three years and above), is also negative with the rise in inflation.

Only the administered rates like public provident fund, RBI Relief Bonds and small savings returns are higher than the inflation now.

The scene in the US, where the interest rates are rising on the back of a creeping inflation rate, is very different. The core inflation rate (that is price of food and fuel) in the US was 1.87 per cent, while the headline inflation was 3.3 per cent in June.

Against this backdrop, the yield on the 30-year US treasury bond is 5.19 per cent and the 10 year bond yields 4.46 per cent.

Even the yield on a 5-year US paper is 3.70 per cent -- offering a 40 basis points real return.

Only at the shorter end, the return on a 2-year US paper is negative at 2. 66 per cent.

Inflation in India has been inching up for four consecutive weeks. It breached the 6 per cent mark in the week ended June 25 when it reported at 6.06 per cent, followed by 6.16 per cent for the week ended July 9.

Dealers said with global interest rates on a high and the US Federal Reserve expected to revise base rates upwards by another 25 basis points, bond rates are expected to go up further.

A similar situation of negative return on bonds was created in the first week of January this year when the inflation rate climed to a 35-week high to 6.09 per cent.