By April, the cruellest month, interest rates were supposed to head down, making life easier for both banks and borrowers. But the much-awaited happy ending to a long period of high inflation and consequently high nominal interest rates seems to be eluding us. A greedy government, which wants to grab some R3.7 lakh crore in the first six months of 2012-13, has sent the yield on the benchmark soaring to 8.6%; that tells you something about where a nervous bond market believes money should be priced. If long-term money is becoming more expensive, it?s not getting cheaper at the shorter end either; an acute shortage of money in the system has compelled State Bank of India, and a couple of other banks, to start paying more for customers? deposits.
The higher rates may not impact the weighted average cost of funds significantly, or their margins for that matter, but that?s not the point. Ultimately, banks have to be able to lend at rates that are affordable for companies and individuals, and if the best risk in the market is priced so expensively, what are lesser mortals to do? Although the recent cut in the cash reserve ratio (CRR) has freed up some R48,000 crore of liquidity, the liquidity shortage persists. But even after that eases, unless their cost of funds stabilises or starts coming down meaningfully, banks can?t be expected to bring down loan rates for their clients.
In all this, the government, which cannot afford to be generous, given the precarious state of its finances, has actually upped the returns on small savings instruments?you can now earn 8.8% tax-free, on your PPF account, which means you actually make more than 10%. It?s true that savings are being eroded by high inflation and that savers must earn a real rate of return so it?s good news because you can now put away as much as a lakh?or R8,000-plus a month?in a PPF account. But it could turn out to be bad news for banks even if half this amount, or R4,000 a month, finds its way into PPF accounts.
Already deposits are growing at a very sad 14% or thereabouts, below what the Reserve Bank of India (RBI) has estimated for 2011-12, of about 16%. That could be partly because of high inflation?consumers now need to hold on to much more money to be able to buy the same basket of goods since the rise in disposable incomes may not have kept pace with the rise in prices. If the trend continues, loan growth will suffer even if banks can raise resources from the equity markets and through the debt route. But, going ahead, inflation could stay elevated for numerous reasons?high crude oil prices that push up imported inflation, a weaker rupee, the recent hike in excise duties and service taxes, and the possible rise in prices of diesel and petrol. That means RBI will find it hard to abandon its tight money policy altogether and can best tinker with the key policy rate until inflationary expectations are brought down. As such, right now, even a cut of 100 basis points over 2012-13, which would take the repo to 7.5%, seems out of reach.
One way to ease the pressure on banks would be to allow more FII investment in the gilts market, perhaps at the longer end; in September 2010, the limit had been doubled from $5 billion to $10 billion, while the limit for investments in the corporate bond market had been increased to $20 billion with some caveats on the maturity. Thereafter, the limits were opened up again in November last year so that the ceiling for investments in gilts is now $15 billion, that for long-term corporate infrastructure bonds $25 billion and the total limit across instruments $60 billion. Foreign investors have typically preferred shorter-term paper, partly because they have been trading in a rising interest rate scenario and also because it?s easier to hedge and exit. Attracting short-term money may not be the best thing to do just now; given how much the rupee is depreciating, the money could flow out as quickly as it comes. But it?s probably better than allowing ECBs because at least with FII investments the depreciation risk is theirs. As for the government?s proposal to mop up money from the markets, through a holding company, thereby allowing it to retain a majority stake in public sector banks?PSU banks need some R3 lakh crore as capital in the next few years?investors have never been thrilled with the holding company route. They are likely to be even more wary now that banks like Union Bank have been downgraded. If the government can?t contribute its share, then loan growth will remain stunted. Banks are in for some tough times.
shobhana.subramanian@expressindia.com