If one were to go round the loan departments of most banks during the course of Diwali shopping, enquiring about the going rates of interest on loans, chances are the citations would display about as much dispersal as fireworks in the night sky. This is not an exaggeration. Immediately after Governor YV Reddy announced the RBI?s mid-term credit policy, bankers who were quizzed about the interest rate scenario were making statements at wide variance with each other. Such an outlook, or lack thereof, is all the more stark in comparison with opinions on interest rate movements in developed markets, where there is rarely any confusion about actual liquidity conditions, let alone central bank signals. Liquidity in large economies isn?t thrown into turbulence by sudden capital inflows, and the benchmark rates used by central banks as policy signals stay within a tightly set range. India, in contrast, is dealing with an unprecedented flood of inflows, and the rate-signalling corridor set by the band of repo and reverse repo rates, at which the central bank lends other banks funds and borrows money from them, respectively, is much wider. This turns the picture of rates quite foggy, making it harder to foresee the future cost of money, and turns the lives of all financial market participants stormy. Thus it would seem it is in everybody?s interest, including bankers, that the rates remain broadly predictable.
To its credit, the RBI has been making considerable effort to narrow the corridor over the years, and to bring call money rates?set by market demand and supply?into alignment with it. The band, in fact, had even narrowed down to 100 basis points at the end of last fiscal. This gave market players the advantage of more accurate calls on rate movements. But subsequent developments in the money market, including the liquidity crisis, has since stretched the band to 175 basis points right now?making rate prediction that much more hazardous. The RBI has set up a committee to examine the subject, but perhaps the big lesson to be drawn is that sharp swerves of policy are not good for rate signalling. So, which way are rates headed? Well, banks are sitting on piles of cash, with loan disbursals down but deposits continuing relatively unabated. Just about six months ago, it was quite the reverse.
