Most economic experts gave their 'thumbs up' to the Budget announced last month for the focus on infrastructure and the rural economy. However, this calls for increased spending -- which in turn could fuel inflation and trigger higher interest rates.

To cut a long story short, if the inflationary concerns become a reality, you may need to tone down growth expectations on your long-term debt funds, and be prepared for some volatility.

Expectedly, liquid funds have done a good job of posting steady growth. Over 1-month, the leading liquid funds have given a return ranging between 0.4% to 0.6%. Magnum Insta Cash (0.6%) is the leader, followed by UTI Liquid STP (0.5%).

Long-term debt funds haven't been as successful as liquid funds in generating growth, at least not with the same degree of consistency. So while we have the leading debt fund -- Cancigo posting 0.7% appreciation over 1-Mth, the last one -- Deutsche Dynamic Bond has generated a return of only 0.2%.

Long-term gilt funds have done a better job of posting growth than both liquid funds and long-term debt funds. Over 1-Mth, leading gilt funds have posted growth in the range of 0.7-0.6%, with ING Gilt (0.7%) leading the way.

The latest Weekly Statistical Statement (as on March 5, 2004) by the Reserve Bank of India [Get Quote] indicates that bank credit surged by 25.6% on a year to date basis (i.e. from April to March 5, 2005).

Demand for credit is on a high in this financial year, a point highlighted by credit growth of just 11.4% on a YTD basis in the corresponding period last year (April-March 2004).

Investors no longer take to bank deposits like they used to. This is a trend we have been observing from the RBI-produced Weekly Statistical Statements. The YTD deposit growth in this financial year (April 2004 to March 2005) is 11.9% as compared to 13.9% over the corresponding period last year.

The 10-year 7.38% GOI bond is roughly at the same level (6.50%-6.60% range) as at the beginning of the year. Consequently returns on debt funds and gilt funds have been unimpressive (read flat).

For debt/gilt funds to dish out superior returns (vis-�-vis liquid funds), bond yields must be on a downward trajectory, rather than in a flat, range-bound movement. For that to happen, interest rates need to be on a south-bound journey, which seems unlikely given the economic growth the country is witnessing presently and aggressive plans for the future.

In an interview, Ajit Dayal, Co-founder and Chairman of Quantum Information Services Ltd ,asserted, 'We believe that interest rates will rise in India by at least 100 basis points this year.'

In any case, India is not the only country grappling with rising interest rate problems. Recent reports indicate that prospects of an economic upturn in the United States, lifted bond yields (and pushed bond prices lower). Any economy in a growth mode has to deal with inflationary concerns, which raises the specter of rising interest rates.

Our advice to investors at this stage is to keep money in short-term bank deposits and short-term/floating rate debt funds.

If interest rates do rise, they can then shift to long-term debt funds to benefit from higher yields and/or even bank fixed deposits.

Variable rate deposits is another investment avenue that investors can consider to beat interest rate blues.

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