Interest rate cycles are taking a turn, banks have started to hike deposit rates and government yields are also hardening. The yields may stabilise in the long term over next few quarters.
An upward risk to inflation and weaker credit off-take will likely bottom out the lending rates and borrowers may have to wait for a longer period to see cut in interest rates.
Tushar Arora Senior Economist, HDFC Bank says, “Even if growth has picked up, I think the current account deficit, fiscal deficit and inflation have worsened and are impacting investor sentiment. In the medium term, we believe 7.5 percent could be the next level by June (for government bond yields). In the near term till around March around 7.3 percent is likely to prevail as most of the negative news is priced in.”
Bond yields are significantly affected by the monetary policy as the policy at its core is about determining interest rates. When interest rates are low, bond yields decline as there is increased demand for bonds. Bond prices and yields are inversely related.
Bond rates vs Deposit rates
At a time when the interest rates in the bond markets are on the rise, government has reduced interest rates on small savings deposits (lending rates follow deposit rates which follow policy rates).
The 10-year benchmark yield to which small savings schemes’ rates are linked, have risen by 67 basis points in the October-December quarter. On Wednesday, the yields closed at 7.32 percent, after rising to 7.39 percent in the early trade.
Despite the monetary policy rate easing cycle that started in January 2015, now coming to an end, the government has brought down small savings schemes interest rates which are to be aligned to market rates or the bond yields.
Experts suggest that the government anticipates the bond yields to ease in the long run.
Starting April 1, 2016, the government had said that interest rates on small savings would be linked to market rates such as the benchmark bond yields. It had also said that rates would be reset quarterly but has not been followed regularly.
Last week, the government slashed interest rates on small savings schemes by 0.2 percentage points or 20 basis points (bps) for the January-March period, a move that will help banks to lower deposit rates.
The schemes include National Savings Certificate (NSC) at 7.6 percent, Sukanya Samriddhi Account at 8.1 percent, Kisan Vikas Patra (KVP) at 7.3 percent and Public Provident Fund (PPF) at 7.6 percent.
SBI cuts base rate while PNB, BoB hikes deposit rates
Further, while State Bank of India (SBI) reduced its base rate (minimum lending rate for borrowers before April 2016) by 30 bps to 8.65 percent, Punjab National Bank (PNB) and Bank of Baroda (BoB) hiked their interest rates on wholesale deposits.
A senior PNB official suggested that the deposit rates were increased purely to meet the bank’s asset liability mismatch. “We also do not expect the lending rates to go down further most analysts suggest the rates are only headed higher from here on.”
Saswata Guha, Director of financial institutions at Fitch Ratings India, does not expect further rise in deposit rates by other banks as banks are still flush with ample liquidity and credit growth is not picking up as well.
“Banks are also sitting on excess SLR (statutory liquidity ratio – the requirement by banks to park liquid funds into government bonds is at 19.5 percent) and until first half of this year, credit growth was just 6 percent. So there is no liquidity crunch for now. The balance may shift with a meaningful revival in credit growth although I don’t necessarily see that happening in the next 6 to 12 months,” he said.
RBI Governor Urjit Patel also sees upward pressure on inflation and has turned cautious stance towards it. In future, rates (policy) will either remain stable or likely harden, implying that upward pressure is a more likely scenario.
On the SBI lending rate cut, Guha adds, “The way they (SBI) have positioned is essentially bridging the gap between base rate and the MCLR. I think this poses a challenge for larger banks but they may also follow suit. However, the prospect of further reduction in rates is probably slowing down.”
The PNB official also doesn’t expect bond yields to increase any further. “Bond yields have already risen… and now after the RBI cancelled two auctions, they will stabilize. It may rise in the short-term but it will stabilize in the long term”.
HDFC Bank’s Arora, expects in the second half of FY19, as the global monetary policy sees further tightening, that the “domestic yields could rise further”.
Moreover, even as banks may follow slight divergent strategies for retail and wholesale deposit rates, analysts see rates in the system trending upwards in the months ahead.
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