Clues from bond street

Clues from bond street

How severe has the recent monetary tightening been? Take a look at the bond market. The interest rates on the benchmark 10-year bonds moved up to 8.2% on Tuesday, the first day that bonds were traded after the Reserve Bank of India (RBI) unexpectedly raised interest rates on 30 March. This is the highest rate in several months, and far above the yields seen just a couple of years ago.

Yields on 10-year bonds fell to as low at 5.1% in October 2004, a mere two-and-a- half years ago. The rate of inflation in that month was 7.1%. So the real interest rates, that is, interest rates adjusted for inflation, were negative.

This is an indication of a very loose monetary policy. The current inflation rate has been hovering around 6.5%, which means that real interest rates on government bonds that mature in 10 years are 1.7%. So there is no doubt that RBI has tightened the screws.

The question to be asked: Is it tight enough? Or is there more in store?