India's Short-Term Interest Rates Poised for Decline Amid Foreign Fund Inflow

Interest rates on short-term financial instruments like Certificates of Deposit are poised to decrease across India. This anticipated drop, estimated at 75-100 basis points by July, follows large public sector units and banks tapping overseas loans and deposits. This influx of foreign funds is expected to cool domestic yields and ease borrowing costs for businesses and the government.

Mumbai: Rates on certificates of deposit (CD) and other short- to medium-term instruments will likely reduce across India after large public sector units and banks tap overseas loans and deposits, respectively, helping cool domestic yields, treasury heads told ET.

They expect CD rates, a key gauge of short-term funding costs, to fall by 75-100 basis points by July, after surging to multi-year highs in the past month.

One basis point is a hundredth of a percentage point.

Average CD rates reached 8.08% in the last week of May, the highest in over two years, central bank data showed. While estimates vary, market participants expect at least $30-50 billion of inflows via the FCNR(B) and external commercial borrowing (ECB) routes.

Rates across asset classes, particularly at the short and medium end of the curve, are expected to ease as banks gain access to cheaper overseas funding.

"CD rates and bulk deposit rates will come down as money starts to flow in. Smaller banks who don't have a larger pool of retail deposits rely more on CDs and bulk deposits, so CD rates coming down will help," said Alok Singh, head of treasury at CSB Bank. "I expect them to soften by 75-100 basis points in the next month or so once the FCNR deposit money is into the system."

Market participants said banks are likely to deploy these funds into domestic assets of similar maturities, including three- to five-year government securities, corporate bonds and short-term money market instruments. This influx is expected to lower rates, thereby reducing borrowing costs across the financial system.

Along with CD rates, the impact can also be seen on corporate bonds, with rates for PSU borrowers softening more than 30 basis points. For example, state owned NABARD raised ₹6,780 crores at 7.34% for three years on Wednesday. Last week, before the measures were announced Friday, NHPC had raised ₹2,000 crores at 7.67% for three years.

In the sovereign bond market, yields on two- to five-year bonds have fallen by up to 30 basis points, led by the 6.36% 2031 bond.

"Softening of rates would depend on where banks deploy the funds they are getting through the FCNR route. The 3-5 year bonds and some short term rates could come off, but I think it will be temporary," said Rajeev Pawar, head of treasury at Ujjivan Small Finance Bank. "Inflation is starting to rise and once we cross September, the problem will accentuate."