But a rally of this magnitude is surprising; investors seem to be in denial of the interest rate trajectory. How could they miss the fact that, at least for now, governor Raghuram Rajan is firmly focussed on fighting inflation even if growth is slowing
Consumer inflation, the RBI feels, cannot be ignored; in its view, the CPI could remain at around or even above 9% in the months ahead, absent policy action.
So, while the additional quantum of borrowings, allowed through the term repo windows, will help bring down the cost of funds for banks marginally, it will be little consolation since money is much more expensive now than it was a year back. And while short-term money could become cheaper, rates at the long end will stay high.
First, because, there are no indications the government will scale back its borrowings and, second, because deposits are hard to come by; at 14-15%, theyre growing really slowly and banks simply cannot afford to upset customers.
If depositors are eluding banks, so are borrowers; the lack of lending opportunities in a tough economic environment, in which assets are turning toxic faster than ever before, is evident from the loan growth numbers. ICICI Banks corporate book grew just 11% y-o-y in Q2FY14 and commentary suggests banks are being very careful about who they lend to. A study by Kotak Institutional Equities shows lenders sanctioned only R22,000 crore across 82 projects in Q1FY14, less than 0.5% of loans one of the lowest levels seen over the past few years.
A combination of high interest rates and caution on the part of bankers cannot be good news for the corporate sector, which is already reeling under a shortage of raw materials, flagging demand and a volatile currency. For a clutch of 299 companies (excluding banks and financials) perhaps not the most robust of samples net profits have risen just 3.8% y-o-y in the September quarter despite the top line growing at 15%.
While a weak rupee has made imports costlier and inflation has pushed up expenses in general interest costs have gone up 38% y-o-y; operating profit margins are up 9% y-o-y.
For small and mid-sized companies the interest tab would have completely eroded the margins. Even if they stood a chance of battling the slowdown, the exorbitant cost of money will put paid to those chances.
And at some point, risk-averse banks will pull the plug. As for fresh investments, its hard to see any promoter committing funds when hes not sure how much hes going to be paying; more important, with the economy slipping, its becoming harder to decide how viable projects are. If the economy isnt turning around and life just got more difficult for companies what exactly are the markets cheering