Equity analysts not revising up their cost of equity assumptions will mistakenly feel that equities are under-valuedThis lack of demand from the government depresses bond yields and prevents it from showing true liquidity scenario. The 10-year government bond yield is of particular interest to equity analysts because the capital asset pricing model uses it to form the “cost of equity” in valuation models. The 10-year government bond yield in the January auction was 7.39% which means it has barely moved from the lows reached. Using this rate in valuation models will inevitably lead to an over-estimation of assets. The third option for tracking interest rate is to look at weighted average deposit rates. This data comes with a bit of lag and because the rate is an average not just fixed deposits but also current and saving deposits it will not capture the size of the move in interest rates. Regardless of these data challenges, it is very clear that interest rates in reality have gone up. Banks which not too long ago offered as low as 5 to 6% on fixed deposits have raised that to 9 to 10%. A 300-400bps move in a short period is a very steep move and the failure to notice this will lead to missed opportunities and losses. Equity analysts not revising up their cost of equity assumptions will mistakenly feel that equities are under-valued. Depositors might also be unaware that rates have been increasing and end up locking in lower fixed deposit rates for long periods.
Banking sector developments have dominated newspaper reports for the last few years. Although non-performing loan formation took the spotlight for a long period, lately the soaring rates on fixed deposits and tight liquidity conditions also came under scrutiny.
Much has been written on why the interest rate cycle has turned so sharply and so I move to a slightly different territory.
My interest is in the public data available on interest rates.
Generally, we can follow a number of the indicators from the central bank website. One is the call money rate -- the rate at which one bank lends to another.
A quick glance at the rates will show that despite all the hue and cry about liquidity crisis the call money rate has barely bulged.
This has happened because there seems to be a verbal guidance from the central bank, as suggested by published media reports, on what the call money rate should be. This obviously makes the call money market less liquid and prevents it from being an indicator we can use to gauge interest rate conditions.
The second option is to look at yields on government bonds. There also we have a problem as the government has ceased to borrow from the bond market for more than two years and instead has been exclusively relying on National Savings Certificates.
