Interest rates on govt bonds to rise

The soft interest rate regime is now over with the rates on government securities likely to harden for at least two years, economic think tank Institute of Economic Growth has said.

The prime lending rate of banks is also unlikely to go down because of the hardening of interest rates on government securities, the institute said in its latest monthly periodical, adding that banks may have to improve the operational efficiency to restrict the rise in PLR.

Pointing out that the Indian financial markets are now linked to global financial system, Monthly Monitor, brought out by IEG, said except for call money rate, all yield rates are expected to move upwards following the upward movement of the international interest rates.

"The soft interest rate regime witnessed during the late 1990s and the early 21st century is now over. The government would have to, therefore, borrow at a comparatively higher cost," IEG said.

The upturn in the interest rates on government securities, which started recently, is now likely to continue for at least about two years, the institute said but added that it may taper off at a peak much lower than recorded during the high interest rate regimes in mid-1990s.

Elaborating the reasons for this trend, the institute said the real interest rate seems to have reached the floor during the industrial slow down of early 21st century.

Besides, the industrial recovery from about 2003 onwards together with the rising international oil prices created a rising inflationary expectation, which have also contributed to this upturn in the interest rates, IEG said.

Also, the persistence of high fiscal deficit and the limit to RBI sterilisation policy option has led to an increase in supply of government securities corresponding to the demand, according to the Monthly Monitor.

To some extent, the upturn is restrained by easy liquidity created by the influx of foreign capital, especially in the form of portfolio investments in government securities and bonds, the institute said.

The periodical also said the floor of the interest rate in a developing country like India is expected to be higher than that of the rich countries with a surplus capital.

The institute also said the policy makers have to take note of the fact that Indian financial markets cannot remain immune to global financial system.

"It was found that although the interest rates depend on some domestic factors such as money supply, yield spread and expected exchange rate, it is majorly affected by the movements of international interest rates, although with a significant lag," IEG said.