If banks are not as convinced as the finance minister that the Rs 89,000-crore extra government borrowing, compared with borrowing estimates given in the interim Budget, won?t push up interest rates, it is because banks are wiser after living through a most curious phase in credit history. This phase is defined by three things. First, lending rates haven?t responded as much as they should have to drop to RBI?s policy rates?the repo has dropped by 425 basis points since October 2008, but lending rates have come down by around 200 basis points. Second, credit off-take hasn?t responded to an easing of the monetary regime. At the end of June, according to RBI data, year-on-year credit growth was 15.68%, the lowest growth rate in five years. Low credit off-take is hurting banks? net interest rate margins. SBI chief OP Bhatt has said his bank is losing Rs 100 crore a day because credit volumes are down. Third, the debate whether low credit off-take can be explained by low borrower interest or low borrower interest is thanks to insufficiently low lending rates went on as inflation dropped and RBI desisted from another round of policy rate cuts. Also, as inflation dropped sharply, government?s borrowing costs didn?t. These attributes point to a central bank policy regime that?s not sufficiently doing either the job of signalling rates or managing government debt.
These columns? opposition to such a work arrangement for the central bank is oftrepeated. Also well-known is the fact that this arrangement isn?t changing any time soon. So, it all again depends on extremely deft handling by RBI of multiple and not harmonious objectives in a situation where bond markets are anxious about high government debt. In such a situation, the smart money will be on lending rates rising if private credit demand picks up just as a huge quantity of government paper comes in. The government and RBI are supposed to work out the borrowing schedule this Friday. One solution that has been advocated for a long time is government bonds being kept on RBI books. But even if there?s clarity on this from government statements, this option raises the question of effective RBI management of its two roles as bondholder and debt manager. These questions may not have been important 30 years ago, but they are important now because a lot of smart people now track this trillion-dollar economy. They would have noticed that RBI and the government did very well to manage the immediate aftermath of the crisis. But the tight money orthodoxy before the crisis and the less-than-fully-effective loose money regime after the crisis don?t inspire confidence. Higher lending rates even before the recovery has taken hold fully will strengthen that hypothesis.
