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If you are thinking Interest Rates(IR) would not go up? Think twice.

Why do I believe IR would go up?

1. Massive inflation across the sectors and categories in India. High prices of Oil.

2. Massive Govt. Spending

3. Gargantuan liabilities of Govt, which requires Govt to borrow 30% of GDP every year thus
pumping enormous money supply in the economy, which coupled with Fractional Reserve
Banking multiplies and floods the economy with cheap currency.

This ends in currency loosing purchasing power and inflation swiping the nation.

4. Monsoon effect. We had worst monsoon post 1972 in 2009. Met dept forecasts normal
monsoon in 2010. But, it still remains worry.


Look closely at above chart. In year 2000 interest rates had reached to as high as 15.5% in
India. Yes, not corporate or multinational, this was the rate of borrowing for Banks from
RBI.On 10th July, 2000, Interest rate was mere 7% and on 9th Aug 2000, in less than a month,
it climbed full 8.5%…..yes whopping 8.5% in less than a month to 15.5%.

We will examine causes later. But, keep in mind that when things get worse, central bank has to
resort to use this last and final tool of jacking up rates as fast as possible to rein in the situation.

Chart also demonstrates very clearly that interest rates have completely bottomed out now and
ready to march upwards.

Question is not only, how high rates would go? But how hasty would it go up?

To answer both of these questions, let us review RBI’s annual policy statement for 2010-11
published on 19th April.

RBI governor looked much concerned about Inflation and got reflected at every other line of
policy statement.

Here are some excerpts

“ Though inflation has started rising in several EMEs, India is a significant outlier with
inflation rates much higher than in other EMEs.

Going forward, three major uncertainties cloud the outlook for inflation. First, the prospects
of the monsoon in 2010-11 are not yet clear. Second, crude prices continue to be volatile.
Third, there is evidence of demand side pressures building up. ”

Here, In very soft and polite language Governor Dr. D. Subbarao expressed his concerns.

Govt Borrowing

These concerns have erupted from below chart!!!!!

Look, How hastily Inflation has gone up? It has doubled in less than a year.

Here, What Mr. Subbarao said about inflation…

“Clearly, WPI inflation is no longer driven by supply side factors alone. The contribution of
non-food items to overall WPI inflation, which was negative at (-) 0.4 per cent in November
2009 rose sharply to 53.3 per cent by March 2010. Consumer price index (CPI) based
measures of inflation were in the range of 14.9-16.9 per cent in January/February 2010. Thus,
inflationary pressures have accentuated since the Third Quarter Review in January 2010.
What was initially a process driven by food prices has now become more generalised. ”

But, think twice, Is inflation only worry? Heck no.

The biggest worry is Govt. Borrowing program. RBI Governor has not shied away to express his
resentment on massive govt borrowing program.

Finance Ministry is to borrow 36% more this year form market compared to last year. If I put it
into figure, Govt is set to borrow Rs. 3,89,300 crore and add borrowing by state govts…..

Put together, RBI has to facilitate borrowing of close to Rs. 5,97,414 crore without affecting
interest rates in year 2010!!!!?????

In current Fiscal, combined expenditure of the centre and states pegged at Rs. 18,92,880

Govt is set to borrow Rs. 5,97,414 crore from markets and would spend Rs. 3,30,389 crore
towards paying interest on earlier borrowings. Remeber, only interest not principal.

Put together, Rs. 9,27,803 crore will be spent in the economy, which is either borrowed
money or goes towards repaying interest .

It is colossal 50% of budgeted expenditure.

Data is taken from RBI. Click to view in detail.

Those, who want to know our Govt’s Fiscal situation, refer to my Fiscal Disaster article. Link:

Meanwhile, Total Liabilities of the Centre and States [ includes internal and external debt,
small savings schemes and provident fund liabilities] has reached to close to Rs. 50,00,000
crore. Yes, you read it right, FIFTY LACS CRORE. Close to 90% of GDP.

And, this does not include off balance sheet liabilities.

RBI Statement on Govt Borrowing program

“ Historically, fiscal deficits have been financed by a combination of market borrowings and
other sources. However, in 2009-10 and 2010-11, reliance on market borrowings for financing
the fiscal deficit increased in relative terms. The large market borrowing in 2009-10 was
facilitated by

the unwinding of MSS securities and OMO purchases, as a result of which fresh issuance of
securities constituted 63.0 per cent of the total budgeted market borrowings.

However in 2010-11, almost the entire budgeted borrowings will be funded by fresh issuance of
securities. Therefore, notwithstanding the lower budgeted net borrowings, fresh issuance of
securities in 2010-11 will be Rs.3,42,300 crore, higher than the corresponding figure of
Rs.2,51,000 crore last year. The large government borrowing in 2009-10 was also facilitated by
sluggish private credit demand and comfortable liquidity conditions. However, going forward,
private credit demand is expected to pick up further.

Meanwhile, inflationary pressures have also made it imperative for the Reserve Bank to absorb
surplus liquidity from the system. Thus, managing the borrowings of the Government during
2010-11 will be a bigger challenge than it was last year.”

Have these concerns started reflecting in Bond Market?

Yes, look at the below chart.

Dotcom bubble crisis in year 2000 swung the rates high close to 12% and later in year 2001,
after 9/11, central banks of the world slashed the rates to jump start the economy.

Similar instance was seen in year 2008, first rates went up sharply and later dived to halt the
economic decline.

What is different this time, that is driving interest rates high??

1. Accumulation of gargantuan debt and liabilities by Govts, which is becoming patently

unpayable even 10 yrs down the line

2. Massive borrowing by central Govts across the world

3. Massive money printing by central banks across the world.


For US central bank, It took 100 years to expand the monetary base to $850bn and in last short
18 months, it climbed to $2.1 trn. i.e Fed created new money worth $1.25 trn out of thin air,
more than 250% new money to what it was 18 months before

That’s an irresponsible, irrational and insane increase of 2.5 times in just 18 months — and you
must not underestimate its sweeping historical significance.

There is no historical precedence to compare such a massive printing.

Same and probably worse is the situation across the Europe.

Last year, Budget deficits of European nations zoomed past 10%, which is considered as red

Debt to GDP

Of late, you have been frequently listening about debt to GDP ratio.

What money managers and creditors closely look at is Debt to GDP ratio of nation to decide the
risk of lending.

Ratio includes 2 factors. Debt and GDP.

In 2008, GDP did not fall much as effects were yet to be felt in real economy. But, to stem the
fall, Govt spent heck lot of money in 2008, mostly assuming that if GDP remains stable, this
debt is payable.

But, in 2009, real economies dived miserably. US decline -2.4% to Russia as high as -7.90%.

Country Real GDP % est 2009

US -2.4
Euro Zone -4.0
Germany -5.0
France -2.1
England -4.3
Russia -7.90

Japan -5.70
India +6.50
China +8.70
World - 1.0

When GDP fell, ratio got ugly.

Example: say country’s Debt was Rs. 70 and GDP was Rs. 100. Hence, Debt to GDP is 70%, fine.
Now, GDP falls by 5%, so 95 and that drives

Ratio to 74%. And, what if next year again GDP falls by 5%, and debt increases by 5%, that
drives ratio to 81%. 10% increase in debt in 2 years and do not forget, Govt has to keep paying
interest on debt which it has been piling up since decades to gather.

This is what precisely happening with Greece, Portugal, Ireland, Italy and Spain.

These nations GDP has been falling since last 2 years, official unemployment rate has reached
as high 20% to 25%, banks are in huge losses due to their sub prime exposure and participation
in interest rate derivatives.

Put all these factors combined with inflation, creditors are scared to lend money to these
nations because their repaying capacity is becoming dismal.

I have also presented table for you of G-20’s Debt to GDP ratio.

Look at G-20 situation

Some Market Reactions:

Warning from Finance Secretary

Bond yields near 18-month high on inflation concern

4 May 2010, 0201 hrs IST,ET Bureau

The benchmark 10-year bonds declined, pushing yields to near an 18-month peak, after finance
secretary Ashok Chawla said inflation at current levels is high.

The yield rose as in vestors also speculated there will be fewer trades in the existing note after
the central bank on April 30 sold a new 10-year bond, according to Devendra Das, a debt trader
at Development Credit Bank. Chawla said inflation, which at current levels is not “socially,
economically or politically acceptable,” may cool by the end of 2010

Corporates are busy raising money before rate hikes

Corporates hit Bond Street ahead of rate hikes

3 May 2010, 0447 hrs IST,ET Bureau


MUMBAI: A host of state-owned and private corporates are expected to raise funds through
fresh debt offerings in the coming days as they try to make

the best of the recent fall in bond yields, ahead of a possible interest rate hike. Dealers say
IDFC, HDFC, Exim Bank, Power Finance Corporation, RIL and IRFC are some of the companies
that may hit the bond street as early as next week. For close to a month before the April
monetary policy review, there were hardly any large issuances.

This flurry of issuances comes in the backdrop of events in Europe hurting appetite for debt of
emerging market economies like India. Companies have so far countered this by selling their
bonds in the local market. For instance, HDFC, Reliance Power and Utilities, L&T Infra, Nabard,
Shriram City Union Finance, SAIL, BPCL and IFCI are some of the companies that have raised
around Rs 6,000 crore in the past ten days. This trend could gain steam in May, dealers said.

Hence, It does not leave any doubt that Interest Rates across the world are set to go up.

Global Perspective

You may think why rates would go up in India?

Answer is Why Indian market tumbled in 2008? Housing crisis had not originated in India
neither our banks were exposed to sub prime or derivatives.

We tumbled along with world markets because we are part of Globalised world. Decoupling is a
mere assumption far from reality.

Our markets fell more than rest of the world in 2008, RBI also joined race to reduce benchmark
banking rates with central banks of the world , our markets recovered in 2009 along with world

None of the last 2 years events exhibits that we can sing a solo economic tune.

For world, borrowing is getting costlier and same will reflect in our bond prices, soon. Hence, be

For Further Details kindly Contact :

Thanks and Regards,

Kirang Gandhi
Corporate Financial Planner