Banks will have to tempt depositors

Written by Shobhana Subramanian | Shobhana Subramanian | Updated: Jul 29 2010, 04:24am hrs
The upshot of the hike in the repo rate by 25 basis points is that money is going to become more expensive sooner rather than later, both for companies and for individuals. Especially since the Reserve Bank of India (RBI) doesnt intend to leave too much of it lying around. The central banks fairly comfortable with the idea that liquidity could be in short supply for some time, beyond which it will be available in adequate quantities. It has little choice; it needs to contain inflation which is threatening to spin out of control. Indeed, it would seem that RBIs inflationary expectations may have been somewhat out of sync with reality; both food and non-food inflation have been running in double digits for some now and thats has been upped to 6% ostensibly, to factor in the impact of the fuel price hike.

However, while theres one school of thought which believes that the central bank should undo the damage by moving faster on interest rates, especially since real interest rates in the economy continue to remain negative, the regulator has chosen to once again take it just one step at a time. For sure, the central bank has been more forceful than it was expected to be and has tweaked the reverse repo rate by 50 basis points, narrowing the corridor. The idea is to make sure that rates are less volatile, which is important now that banks need to have in place a base rate below which they cannot lend.

Moreover, the RBIs making sure that it can mop up any money that banks may have as surplus. Its a very unlikely scenario of course that banks will have any money to spare because money is already in short supply. Moreover, deposits arent coming their way at the pace that that they were some time back, partly because surpluses parked by PSUs seem to have been put to work and partly because currency in hand has gone up because of higehr inflation. So that means banks will have to try and tempt savers with higher deposit rates and pray it works. Also, the government needs to spend quickly, a move that would increase the money supply in the system. But since demand for loans is expected to remain strong its currently running at 22% or thereabouts--- both corporates and small borrowers can get ready to pay more for their loans.

Fortunately, the capital markets have been resilient and companies have been able to mop up money from the secondary markets so far this year, about Rs 15,000 crore has been raised by companies from institutional players. But thats by the bigger companies; smaller companies will almost certainly have to shell out more to banks for money to run their businesses.

Interest costs account for a relatively small share of a companys costs and unless theres a very sharp increase in rates, concerns on this front would be minimal--in the June 2010 quarter, for example, interest costs for a sample of 227 companies, has risen 16.3%. With the growth momentum sustaining, companies are unlikely to worry about higher rates upseting capex and consumption just yet. Thats why the market shrugged off the rate hikes even though the RBIs tone was more hawkish than expected.