In his Budget, finance minister Pranab Mukherjee announced plans to
bring down fiscal deficit from 6.5% of gross domestic product (GDP) in
FY10 to 4.8% in FY12 and 4.1% in the following year. Anxious investors
got a sigh of relief. Within minutes of the announcement, the Sensex
shot up and yields in the bond market eased down a bit.
The yields were expected to soften as it seemed that the government
would be raising lesser amount from the market. However, the way bond
yields have behaved in the past 10 days, it doesn’t seem that they are
going to soften in the short to mediumterm. The yield on a 10-year
government paper stood at 7.8% on February 25, 2010, just before the
Budget day. The yield has shot up by 21 basis points (bps) since then
contradicting the conventional wisdom that with the expectations of
deficit coming down, bond yields too should follow suit. A bond dealer
on the condition of anonymity said: “The demand and supply for the
government bonds don’t match up. It is expected that the government
gross borrowing will be around Rs 5,50,000 crore from the bond market
in FY2010, but the demand seems to be only in the range of Rs 4,50,000
crore.” Obviously, an expected shortfall in demand for government bonds
is pushing up the bond yields.
Another reason for a fall in the demand for government bonds is the
recent uptick in the banks’ credit growth. The credit growth improved
from 11% in December 2009 to 15% now. With more and more of banking
funds finding their way in (non-government) credit, lesser will be
available to fund the government’s deficit. The situation was exactly
opposite last year. When the credit growth fell to 11% bank’s
investment in government securities jumped by 25%. Experts are worried
that without any intervention by the Reserve Bank of India (RBI) in the
form of market stabilisation scheme (MSS), yields may remain firm.
Central banks across the world buy and sell government securities in
the market and try to influence interest rate and exchange rates.
There are other hints in the market as well, which indicate that low
interest rate may well be a thing of past for some time now. For
instance, ICICI Bank and HDFC Bank hiked the lending rates on Car loan recently.
Moreover, HDFC Bank and ICICI Bank have discontinued their special home loan
schemes that offer lower home loan rates for first few years of the
loan. This means that even banks are now gearing up for higher interest
rates. The interesting question to ask is: Will increase in interest
rate thwart the revival in the Indian economy? Most of the experts
don’t feel so. They think that the bond yield on 10-year government
paper will remain in the range of 8%. And, banks’ lending rate will
inch up, given the gradual improvement in economy. The rationale here
is that India’s economy is recovering from the sluggishness it has seen
in last year. The growth in index for industrial production (IIP)
improved to 16.8% in December 2009 after plunging to a negative
territory a year earlier. In an environment like this, a few basis
points rise in the lending rate is not likely to have a significant
impact on credit demand.
So, what are the cues for retail investors? Since bond yield is
expected to remain high, the short to medium-term debt schemes will not
be able to give as high a return as they could last year. And, any
marginal run up in bond yields should not be misconstrued as negative
for stock market. It is actually an aftereffect of rising credit pick
up. So, equity market may not necessarily move in negative territory
given the movement in the yields in last few days.
More: http://www.hsengine.com/s_banking+growth+rate.html
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