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Interest rate dilemmas

The suggestion Finance Minister P. Chidambaram made recently at a joint meeting of bankers and top automobile industrialists — that the banks find ways of raising funds at less cost and, consequentially, lower the interest rates —will have a far reaching impact. The automobile industry has done well recently, aided to a large extent by liberal bank loans at low interest rates for buying trucks, passenger cars, and two-wheelers. Although banks, especially the pu blic sector ones were known to be slow in dispensing retail loans, once they moved into the area, they started vying with one another in devising and marketing attractive packages for buyers of cars and homes. Coincidentally, the interest rate cycle was down to its lowest levels a few years ago. During 2003-06, bank credit to industry increased by more than 30 per cent every year and it moderated only slightly the next year. For most banks the share of retail loans went up from almost nothing to nearly 50 per cent. Inevitably in the rush to meet their targets, some banks ignored the prudential norms while some others were lax with their documentation procedures. A consolidation phase was inevitable but it is the rise in interest rates rather than greater prudence that has kept the number of eligible applicants at a reasonable level.

The strong growth of retail loans is a significant development but it is the bigger picture alluded to by the Finance Minister that is far more important. The proliferation of these loans pushed up demand for the products of certain key industries such as automobile with abundant forward and backward linkages. The rising interest rates rendered these loans expensive. This has moderated demand for several of the products including passenger cars. The prospect of a slower manufacturing growth leading to a slackening in the overall GDP growth is what has been worrying the government. However, there are, as of now, only the faintest signals of an economic slowdown. The Reserve Bank of India’s GDP target for this year is 8.5 per cent and most others expect the economy to grow at an even higher rate. More important, it is the RBI that influences the interest rate policy. For almost 18 months now, it has been signalling higher interest rates to maintain price stability. Whether the RBI has modified its stance in favour of a softer interest rate regime will be known on October 30 when it comes up with its review of the monetary policy. Even if the central bank does signal lower interest rates, it would be on account of a number of factors, and a presumed slackening of demand in key industries will be just one of them.

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