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Interest rates: banks take up RBI signal

But intriguing Government directive to PSBs may slow upward trend

THE MOST obvious message from the Reserve Bank of India's first quarter review (July 25) is that the threat of inflation is real and has to be tackled head on. The 0.25 percentage point increase in repo rates, though widely anticipated, is meant to dampen inflationary expectations. This is the second time in as many months that repo rates have been hiked by an identical margin.

The immediate consequence has been higher interest rates. Though these were already on the rise, banks have followed the RBI's signal. Banks that did not raise their rates earlier are now doing so in quick succession.

As happens always, it is bank lending that bears the initial brunt of a general interest rate hike. By the middle of last week three leading government owned banks, SBI, Punjab National Bank and Bank of Baroda, had marked up their lending rates by 25 to 50 basis points. Their action is bound to set the pace for other banks and financial institutions.

Further hikes stalled

Or so it seemed until the middle of the week. But in a development that is bound to have major consequences for the entire financial sector reform, the Union Finance Ministry stepped in. A letter written by a senior ministry official asking the government-owned banks to refer interest rate hikes to their boards has effectively stalled further action on the interest rate front.

According to Union Finance Minister P. Chidambaram, the Government is well within its right to "advise'' banks the way his ministry has done.

After all, the Government as the majority shareholder in PSBs is entitled to air its view.

Quite apart from the contemplated interest rate hikes — which will surely be deferred if not dropped — the Government's move hits at the core of reform.

Every PSB head, beginning with the newly appointed SBI chairman, is bending backward to comply with the Finance Ministry's advice. Even if some good sense prevails and a few banks choose to stick with the interest hike, the damage would have already been done.

The new prime-lending rate (PLR) of all these banks is 11.5 per cent. The concept of PLR has lost its original significance — of being a benchmark relevant only for first class borrowers. Aggressive and often-injurious competition among banks has resulted in top corporates getting loans at below PLR rates. This practice is still widespread even though many of the leading banks had informally decided not to undercut each other.

Hence, in the first instance, the difference between sub-PLR rates and PLR rates may narrow down but many corporates will continue to enjoy the munificence of banks. More so if the rate hike is rolled back.

A sector that has witnessed one of the highest credit utilisations, namely housing, will be squeezed by the rising interest rates. HDFC has increased its lending rates, both fixed and floating. All others are expected to follow suit.

Incidentally, not long ago, the option to take a home loan on a fixed rate basis seemed overcautious. A floating rate loan looked much cheaper and the possibility of a general rate increase seemed remote. Yet those who did book loans on a fixed rate basis — much against the advice of even some loan providers — have turned out to be far sighted.

Deposit rates untouched

Predictably there is not much action on the deposits side. Two banks — ICICI Bank and Kotak Mahindra — are offering eight per cent for deposits slightly over one year. Some of the smaller private banks have been quite aggressive and are offering higher rates but for longer tenures.

There will be an accelerated trend towards longer tenures and higher deposit rates. Bank of India is offering eight per cent for a ten-year deposit. The recent Government notification extending Section 80 C benefits (under the IT Act) to bank deposits with tenure of five years and more will also raise the number of deposits with long tenures. Until recently a three year deposit was the longest most banks offered.

Senior citizens are offered anywhere between 0.5 percentage and one percentage point over the normal fixed deposit rates. With this extra, some banks will be offering nine per cent, the rate the Government is paying on its senior citizens scheme, which has an implicit subsidy element.

This is one instance of market interest rates catching up with administered interest rates. It is time now to revisit the controversy over EPF and the other remaining rates, which were then seen to be "unsustainable".

The RBI's stance on interest rates has been justified on a number of counts. Non-food credit, money supply, and deposits have all been growing ahead of expectations. The impact of high petroleum prices will continue to be felt for a long time. So far, despite price increases in transportation fuels (petrol and diesel) Indian consumers have been kept insulated to a large degree. But at some stage the full brunt of costly global oil will be felt. This is a worrying development also because global oil prices are not expected to come down in the near future. In other words, the recent hikes may have a "permanent'' component. In fact it is the high petroleum prices that is the single important cause for the rise in inflation expectations elsewhere too. High-energy prices, aggravated by geo-political tensions have forced monetary authorities everywhere to tighten their stance. Given the increasing interconnection between the domestic markets and global ones, India cannot afford to have a bias towards softer interest rates any more.

C. R. L. NARASIMHAN

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