Between March 2010 and 2011, RBI raised the interest rates by 200 basis points. In response, in the same period, the commercial banks raised their lending rates by 50 to 75 basis points less. So, as RBI mulls another rate hike next week, what are the chances costlier money will translate into higher lending rates by banks? A look at the table shows, till the middle of 2010, the banks hardly moved despite the prod by RBI. In fact, the apex bank was also simultaneously raising the reverse repo or the rate which banks earn when they park surplus cash with RBI. There was obviously a strong demand on RBI from the banking system to keep doing so as liquidity sloshed around in the system.
The curious thing is the trend thereafter. By October, the effect of the huge loans for the 3G auctions made by the banks to the telecom companies and the turning bad of micro-finance ones made liquidity very scarce in the markets. In response, RBI had to resort to open market operations to pump in additional funds into the banks and keep open the daily second borrowing window, though it was meant to be a temporary facility. The net effect of the sustained liquidity crunch since October last year and the sustained rise in the benchmark interest rates by RBI should have, therefore, made the banks rapidly push up their lending rates, too. But, as the table shows, the RBI action has got diluted in transmission.
Sure, there are indications that it is becoming difficult for the banks to hold on to their base rates. For instance, the table shows in the four months from December until now, when RBI has heated up the water by 75 basis points, the strongest banks (which typically populate the lower end of the base rate) have raised their rates by 65 basis points. So, the degree of freedom or the slack in the system is certainly coming down. Compare this with the almost flat response of the banks from March 2010 to September 2010 to a 100 basis points rise in benchmark rates.
What were the reasons why banks have been so reluctant to make loans costly for the economy? RBI data shows that till the end of February 2011, non-food credit has grown by less than 17% in this fiscal. Compare this with an even worse 11% in the year before and it?s obvious the growth still has a way to go before it reaches anywhere near 20% plus, the marker set by the Prime Minister?s Economic Advisory Council, for instance. In fact, the breakdown of the figure shows that agricultural credit is actually down from last year. Compared with a 24% growth rate that partially accounted for the rapid burst of growth of production in the sector, it has come down to 18%.
While industry has made up for this gap, moving up to 26.5% against 20% last year, the larger growth story is loans to commercial real estate and non-banking finance companies (NBFCs). There are a couple of other sectors that have shown fast growth rates, but those like tourism are too small to impact the decisions by the banks to change their rates. None of the other sectors are big or growing fast enough for the banks to be confident that the growth trajectory will keep up, even if they hike rates.
Interestingly, other than commercial real estate, the other villain in the inflation roll?the housing sector?is also rather tepid. Including priority sector loans, credit to this segment has not grown sharply in 2010-11, averaging just 14% on the back of a poor 6.4% growth rate in the year before. So, as RBI searches for the elusive inflation virus in this mix, the banks have given a clear indication that they believe the reason for the disease lies elsewhere. It is this mismatch that accounts for the lower transmission efficacy of the interest rate signals from RBI to the banks and from there to the rest of the economy.
Possibly a key reason for the hardening of the inflation trends is the increasing pace of financial inclusion that is taking place in the economy. RBI numbers show that in terms of volume, loans to weaker sections is now the third-largest segment of loans given by Indian banks, excluding large industry. The category is largely government driven but, at R1,91,843 crore of total banking credit, it is far bigger than either credit to commercial real estate or those given to NBFCs. It has grown at 17.6% in 2010-11.
Since a large percentage of those loans is now getting ploughed back into the economy as demand for mainly goods, the inflation potential from them is mounting fast. Of course, it will be necessary to disaggregate the loans to ascertain the percentage reaching the right segments, but the upside on the price level is definitely there.
But these are issues on which RBI will have little to offer in terms of policy guidelines. Instead, it may have to be factored in as concomitant to growth and worked in accordingly.
subhomoy.bhattacharjee@expressindia.com