HOME
NEWS
BUSINESS
MOVIES
SPORTS
CRICKET
GET AHEAD
SHOPPING
rediff NewsApp
Rediff News
All News

NewsApp (Free)

Read news as it happens
Download NewsApp
Rediff.com  » Business » The RBI's tactical coup

The RBI's tactical coup

ShareComment
Text size:  A   A   A
May 13, 2006 13:40 IST

The honeymoon of India Inc as well as the retail consumers with the low interest rate regime is finally over. ICICI Bank, the country's second-largest financial intermediary, hiked its home loan rates last week, for the fourth time this calendar year.

Housing Development Finance Corporation, the mortgage behemoth, has hiked its home loan rates twice since February. Home buyers who were paying interest rates as low as 7.25-7.5 per cent for floating rate loans will now have to pay 9.25 to 9.50 per cent interest.

The cost of short-term corporate loans for prime borrowers, which was about 6.5 per cent last year, has now gone up to 8.5 per cent or so. Long-term loans are now attracting over 9 per cent interest rates. Almost all public sector banks have hiked their prime lending rates by 50 basis points (one basis point is one hundredth of a percentage point) over the last fortnight.

The situation is quite ironical. In January, the Reserve Bank of India hiked its repo rate (the rate at which the central bank infuses liquidity in the system) and reverse repo rate (the rate at which it sucks out liquidity) by 25 basis points each to 6.5 per cent and 5.5 per
cent, respectively.

There was also acute tightness in liquidity following the redemption of over Rs 30,000 crore (Rs 300 billion) worth of India Millennium Deposits. And yet banks did not hike their lending rates.

This time around, the RBI has left the key policy rates untouched and there is plenty of liquidity in the system. The excess inter-bank liquidity is around Rs 60,000 crore (Rs 600 billion) and the RBI has been forced to resume its MSS (market stabilisation scheme) auctions to drain money from the system.

What does this mean? There can be many interpretations of the situation. The most crude way of looking at this phenomenon could be a complete disconnect between the regulator and the market players. Commercial banks do not respond to the RBI's signal for rate hikes and act exactly the opposite when the central bank opts for the status quo.

Another interpretation is that the public sector banks, which account of three-fourth of the banking industry, could not hike their lending rates earlier even if they wanted to, because of moral suasion by Finance Minister P Chidambaram, who repeatedly appealed to the industry not to derail the growth momentum by hiking corporate loan rates.

They have now got the "licence" to revise the rates and have been doing this with a vengeance to restore the shrinking net interest margin (NIM – the difference between the interest earning on loans and cost of interest on deposits) and sagging profitability.

Neither of these interpretations is entirely correct. The fact of the matter is that commercial banks started jacking up rates in January itself. Now they are merely making it official.

Without tinkering with their PLR (which in any way has lost its meaning since bulk of the borrowers access loans at sub-prime rates), banks were increasing their rates both for corporate as well as retail lendings.

It was done by reducing the spread below the PLR for all loans. For instance, instead
of offering four percentage points below PLR, banks were giving loans at three percentage points below PLR or so. However, this method can be applicable only for new loans as old loans cannot be repriced without revising the PLRs.

By hiking their PLRs, the banks are repricing their entire loan portfolios. The RBI can legitimately claim a tactical coup: it did refrain from hiking the key rates and yet the purpose of tightening the monetary policy has been achieved.

However, going forward, the central bank may not be able to repeat this strategy. At the Asian Development Bank meet in Hyderabad last week, the finance minister made it clear that external developments (read: movement of crude oil prices) would have a bearing on the interest rates.

The RBI, on its part, is also preparing the ground for a hike by saying it is watching the situation closely. In the first week of May, the Australian central bank raised its interest rate by 25 basis points to a five-year high of 5.57 per cent amid worries that the inflation
rate would rise, riding on strong global growth and surging commodity prices.

The European Central Bank and Japan have been bracing for a rate hike. The Federal Open Market Committee will also probably hike the US base rate by another quarter percentage point to 5 per cent since most of the economic indicators are positive even as the payroll data is quite soft. Global markets are speculating whether the Fed will press
the pause button at 5 per cent or take it all the way to 6 per cent over the next one year.

Even if it presses the pause button, the RBI has little choice when it takes up the quarterly review of the monetary policy in July. If oil prices are a worry on the external front, the monsoon will also have a bearing on its decision. Sensing an upward bias, the 10-year government bond yield, which dropped to 7.3 per cent last month from a height of 7.55 per cent after the central bank refrained from effecting any rate hike, has climbed back to 7.5 per cent. The rise in loan rates is much sharper. It will go up further as there is no slowdown in the demand for credit.

This piece was written before Wednesday's Federal Open Market Committee meeting
Tamal Bandyopadhyay
Source:
ShareComment