Indian interest rates may rise over short-medium term despite recent easing in yields

New Delhi: Indian interest rates are likely to continue moving higher over the short-medium term despite a recent pullback in yields following US midterm election results and softer global market conditions, a report said on Friday.

The report from Axis Bank said developments such as potentially lower oil prices, reduced funding demand linked to artificial intelligence investments and lower US Treasury yields have weakened some of the near-term catalysts that had been pushing Indian rates higher. However, longer-term structural factors remain firmly in place.

"India yields peak in October, before AI selloff and US midterms India rates were boosted in the first three weeks of October with global benchmarks and crude oil added to by signs of broadening and generalising of India inflation and open market operations sales," the report said.

Slow-moving fundamental drivers remain in place in terms of convergence of India rates with global benchmarks and MIFOR, as well as risks on the inflation side, it said, mentioning reasons for end in fiscal consolidation with the pay commission in the coming year.

Other reasons include slowing deposit growth following the impact of FCNR inflows and limited foreign portfolio investor interest in Indian debt.

“Even though the configuration of the domestic economy might call for a lower nominal neutral rate, rational expectations on the INR and tight global financial markets are imposing much higher levels,” the report added.

It forecasted that global conditions are unlikely to change markedly and the direction of travel on Indian rates to be higher, towards 8 per cent levels that have not been seen in years. However, it maintained that the process will be slow going forward.

“We continue to expect the repo rate to be raised to at least 6 per cent neutral. This follows from normalisation of inflation from very low levels, and is not so much a hike as a normalisation cycle,” the report said.