The Reserve Bank of India is unlikely to raise the benchmark bank rate and the short-term repurchase (repo) rate although the Federal Open Market Committee in the United States is scheduled to hike the Fed rate by at least 25 basis points (one basis point is one hundredth of a percentage point) to 1.25 per cent on June 30.
The bank rate, the rate at which the RBI offers refinance to commercial banks, is now at a four-decade low of 6 per cent. The repo rate, the rate at which the RBI temporarily sucks out liquidity from the system, is now 4 per cent.
Knowledgeable sources say that Indian rates have not historically changed in step with the Fed rate.
"The existing rates are relatively high and liquidity conditions are very comfortable, with banks putting Rs 60,000 crore (Rs 600 billion) in the RBI repo window. The question of the RBI raising rates does not arise now," said a senior banker.
At the same time, CEOs of banks are readying for a hike in lending and deposit rates. "The Budget will hold the key. We are looking closely at the cost structure. Deposit rates could go up by 25-50 basis points. Without raising our prime lending rate (PLR), we can re-price loans by changing the spread over the PLR," the chairman and managing director of a large, listed public sector bank told Business Standard on Saturday.
The PLRs of public sector banks are relative high at 10-11 per cent. Without changing the PLR, banks can hike the lending rate by widening or short-ending the spread.
For instance, a prime borrower, who is now raising a loan at, say, 3 percentage points below the PLR, can be charged 2.5 percentage points below the PLR. Similarly, one who is now paying 2 percentage points above the PLR can be charged 2.5 percentage points over the PLR.
The yield on the benchmark 10-year government paper touched a 13-month high of 5.90 per cent on Friday before closing at 5.85 per cent. The southward movement of bond prices -- bond prices and yields move in opposite directions -- was triggered by RBI Governor Y V Reddy's statement last week that there was evidence of interest rates hardening in the developed world.
Some marketmen interpreted this as the governor's way of talking interest rates up. In August 1997, a seemingly innocuous remark by Reddy on the foreign exchange market -- "any currency could come under speculative attack if its exchange rate is out of alignment with fundamentals" -- sparked a run on the rupee.
However, senior bankers do not read too much into Reddy's statement on interest rates. "For any changes in interest rates, the RBI is more influenced by domestic factors than external developments like a Fed rate hike," said a banker. At this point, the focus was on stability and liquidity, and no rate hike was warranted, he added.
Bond rates, however, have been shooting up on uncertainties over the new government's economic policies and inflation. Bond dealers said the yield on 10-year benchmark gilt could go up to 6.50 per cent and the exchange rate of the rupee could dip to around 46.5 per dollar by the end of the second quarter (July-September) of the current financial year.
The problem, according to some observers, is that most market players are long on equities and bonds, and short on foreign exchange. With global rates going up and the dollar gaining against other currencies, companies have been caught on the wrong foot as most have kept their foreign exchange positions unhedged.
"With the rupee slipping against the dollar, about 30-40 per cent of the unhedged exposure has been covered over the last fortnight. Still, about $12 billion worth of exposure remains unhedged," said the treasury head of a foreign bank.
Over the last two years, Indian corporations indulged heavily in carry trade -- they borrowed dollars cheap and converted them into rupees without taking any forward cover, thereby enjoying about a 4 percentage point interest rate advantage.
"Now, the carry trade is over. Companies are rushing for cover as they run a huge risk," said another foreign exchange dealer.
Churn in the market