In the past few years, especially since 2001, the Indian banking sector has been showing strong growth in profits. This is largely due to the boom in retail lending and also the treasury income whose rise can be attributed to the low bond yields. But the second quarter (April-June) of 2004 has witnessed the benchmark 10-year bond yield rising by 70 basis
points. Currently, the 10-year bond yield is hovering above the 6.0% levels. Rising bond yields is a common phenomenon. However, according to Prof. Shankarshan Basu of IIM – Bangalore, what is really fascinating is the movement of the bond yields along with the stock market movements. He says, “In most economies, stock markets and bond yields move in opposite directions but in India they move in the same direction (for whatever reason).” Owing to increasing interest rates in the rest of the world, the rising inflation level, which is now going above the 7.5% level, and the fears of interest rates moving northwards have resulted in the current trend of rising bond yields. The Economic Survey released in July 2004 suggested the possibility of rise in interest rates as the fiscal deficit continues to be high and there are indications of a possibility of ascend in credit to the industrial sector. Both are interrelated, the Survey says. When private investment picks up, any undue pre-emption of resources by the government to fund its
deficits will lead to a rise in interest rates.

However, the Reserve Bank of India (RBI) has not been giving any indications that the interest rates will rise in future, even though the rates across the globe are showing a rising trend. The RBI has not been keen to raise the interest rates. But it should be noted that neither has it reduced them. Prof. Basu says, “Indian interest rates will have to rise—not very steeply but to some extent. We are always at a lag with the international markets (even when cutting interest rates) and the delay in raising them is no exception. In fact, there are enough indications of interest rates possibly rising with the RBI leaving interest rates untouched for quite some time— this implies that the southward bias of the interest rates is over and from now it can only move northwards.”