As Brescon Corporate Advisors Ltd managing director Nirmal Gangwal aptly points out: "Even RBI would accept that lower interest rates could not be translated into increased advances. In this context, an opportunity has been missed for using lower cost of borrowings to accelerate economic growth since credit comfort among lenders has been a stumbling block for credit offtake. The credit risk spread between financially sound and not-so-sound corporates continues to be abnormally wide. Banks have parked their funds in SLR (statutory liquidity ratio) paper to 37 per cent on an average as against the stipulated requirement of 25 per cent. This has lead to abnormal and unfavourably skewed interest rates."
Credit Rating and Information Services of India (Crisil) chief economist Subir Gokarn says that attempts at softening interest rates may not immediately pass on to all categories of borrowers because of structural bottlenecks. The intermediators -- banks -- have their own concerns, and these cannot be tackled overnight. "But we have to accept that there are issues of these sort, and in the short-run, deal with it with liquidity measures."
|The pass-through of the changes in the policy rates on to the interest rates on advances generally charged by banks has remained fairly low, despite a number of favourable enabling developments like reduction in administered interest rates over the last couple of years, cuts in the CRR coupled with an increase in the interest rate paid by the Reserve Bank on eligible cash balances. The differential of PLR vis-a-vis the yield on government securities (10-year) as well as vis-a-vis deposit rates has, as a result, increased in the recent months. There is also some evidence that the spread between the interest rates charged by banks to different borrowers has widened|
Adds Dr Gokarn: "You may see the credit policy as ignition or as fuel. As an ignitor of a revival. Or as a fuel supplier of liquidity. That there are signs of revival and you keep the fuel tank full." But the hard point Dr Gokarn also makes is that operationally, "The central bank is only an agent of the short-term."
The other day, a senior foreign banker made it clear that corporate Indias clamour for still softer lending rates is not going to lead to an economic recovery. His point was simple: a 50 basis points (bps) cut in the CRR or the Bank Rate does not make it any more attractive for banks to lend. Implicit in this statement is this fact: if it is believed that still lower interest rates and a surfeit of liquidity will force banks to lend, then it has dangerous portends. Nothing should be forced, especially in money matters!
Says former RBI deputy governor SS Tarapore, whose stand is at complete variance with the monetary policies now being followed: "You can stop a horse from drinking water, but you cannot make it drink. Frankly, you are feeding a sick man sweets!" He agrees with Dr Gokarn that the central bank is only an agent of the short-term, but adds: "What is the long term, but a series of short ones... are you now saying that future short-term rate is 7.50 per cent (based on the 30-year paper)."
Let us see what the RBI feels on the transmission issue. In its Annual Report for 2001-02, there is this box on Policy Instruments And The Interest Rates Spectrum: Identifying the pass-through.
"... In the Indian context, the year 2001-02 witnessed one of the sharpest declines in interest rates: the yield on 10-year government securities declined by as much as 287 bps points and the Bank Rate, the repos rate and the overnight call money rates also eased significantly. However, the pass-through of the changes in the policy rates on to the interest rates on advances generally charged by banks has remained fairly low, despite a number of favourable enabling developments like reduction in administered interest rates over the last couple of years, cuts in the CRR coupled with an increase in the interest rate paid by the Reserve Bank on eligible cash balances. The differential of PLR vis-a-vis the yield on government securities (10-year) as well as vis-a-vis deposit rates has, as a result, increased in the recent months. There is also some evidence that the spread between the interest rates charged by banks to different borrowers has widened."
It is pointed out that an important factor determining the successful conduct of the monetary policy is the effectiveness of the channels of monetary transmission. Monetary impulses are transmitted to output and prices through a host of channels. In practice, the critical issue in the choice of the transmission process is the degree of pass-through -- the speed and the magnitude of the response of the market interest rate spectrum to the monetary policy signals.
Available empirical evidence on the pass-through indicates that loan rates are sluggish in responding to monetary policy actions with lags ranging from several weeks to several months depending upon the nature of the borrower/loan; even over time, the pass-through is less than unity. Moreover, the response is asymmetric -- loan rates generally react faster and more completely when policy is tightened than when policy is eased. This has an important implication for the transmission mechanism with a monetary tightening being more effective than a monetary easing of the same magnitude.
The RBI Annual Report goes on to add that empirical evidence for the US during the 1990s indicates that the pass-through from the Fed funds rate to the prime rate increased significantly, becoming almost immediate. Pass-through for housing mortgage was also quite high. For other loans (car loans, credit cards and personal loans), the pass-through increased by 3-4 times during the 1990s, but was still lower than unity. Credit card rates remain the stickiest with pass-through of only 0.3 during the 1990s.
The increase in response of interest rates to monetary policy signals during the 1990s can be attributed to changes in the financial structure, increased competition between banks and from non-banks, greater monetary policy transparency, more use of securitisation and variable-rate loans. An important implication is that a smaller change in the policy rate will achieve the desired change in the lending rates. A higher pass-through implies that financial markets have become forward looking and this would lead to decline in transmission lags. Institutional changes are, however, a pre-requisite for a uniform pass-through of policy signals across the entire spectrum of interest rates.
"There is nothing more dangerous than hoping that banks will be forced to lend. They will wind up with more NPAs," says Dr Tarapore. It would be worthwhile going through what Dr Tarapore said at the Financial Sector Roundtable organised by Economist Corporate Network and International Market Assessment India Pvt Ltd a couple of months back.
"There is a conspiracy of silence to which borrowers, financial intermediaries and the supervisors are a party. I am well aware that such a statement will cause apoplexy in many circles, but the time has come to remove the purdah on NPAs. It is not as if banks are the only ones with NPAs. In all probability, non-bank financial intermediaries carry an even larger burden of NPAs... From an outside assessment, it would appear that the government would have to provide a minimum of Rs 30,000 crore to ease the pain of the financial sector... It is necessary to undertake a holistic assessment of the burden on the fisc. Admittedly, government support would be staggered and it would be argued that support for different types of institutions cannot be clubbed. But the fact remains that the fisc is one and it cannot pass the buck. While there is considerable euphoria that in 2001-02 all banks which were earlier in the red have shown substantial improvement, it is clear that this is largely attributed to the bonanza on investments in government paper. This cannot repeat and in 2002-03, a number of banks will be back in the red and would turn to the government for largesse."
So we are back to square one -- there might be liquidity, but banks may well not be in a position to lend because of their own constraints or what Dr Gokarn referred to earlier as "structural constraints."
Sadly, it is hard to get a real fix as to who is borrowing at what rate, even sectorally. There is just no data. But then you have Crisil, and it came out with some interesting observations on the credit markets.
Last week, Crisil released its Rating Trends: A Changing Tide, But Yet To Turn. It said: "The first half of 2002-03 may hold promise of a change in economic direction. Improvement in some core sectors in the last six months has resulted in an improvement in Crisils credit ratios (ratio of upgrades to downgrades). While the number of upgrades in Crisils long-term ratings portfolio during 2001-02 and for the first half of 2002-03 both equalled four, the number of downgrades during the first half of 2002-03 was significantly lower at 10 as compared to 38 during the whole of 2001-02. This sign of improvement was despite the depressed economic trends and downward rating pressures witnessed during FY2001-02 and lingering concerns about the weak monsoon during the current year. However, the credit ratio is still less than one, as downgrades continue to outnumber upgrades and, therefore, it would appear that any strong economic recovery is still some distance away."
And this is what Crisils executive director and chief rating officer Roopa Kudva had to say: "The likelihood of this change in economic direction growing into a meaningful improvement in the state of the economy would be critically dependent on the growth in investment activity."
Higher modified credit ratio indicates improved credit quality. The modified credit ratio, which is defined as the ratio of (upgrades plus reaffirmations) to (downgrades plus reaffirmations), is an effective indicator of systemic credit quality. Crisils modified credit ratio for long-term ratings improved to 0.95 in the first half of 2002-03 as compared to 0.87 in the first half of FY02 and 0.85 for the whole of FY02. Similarly, the modified credit ratio for Crisils fixed deposit ratings improved during the current years first half to 0.98 as against 0.92 in the corresponding period last year and against 0.89 for the whole of FY02. This may indicate that the sign of improvement in systemic credit quality which was observed in FY00, but which retracted in FY02, is re-emerging. Improving credit quality is in step with underlying economic fundamentals.
Crisil said that its modified credit ratio continues to exhibit a strong correlation with macro-economic indicators such as the growth rates of the Index of Industrial Production (IIP) and gross domestic product (GDP), the real interest rate and the aggregate quantum of equity mobilised by corporates. The higher modified credit ratio in the first six months of FY03 reflects the improvement in these parameters during this period. This includes a rise in IIP by 6.4 per cent and greater equity mobilisation (over 60 per cent growth).
But there is no disputing the fact that credit is proving to be tougher for some critical sectors of the economy. The RBI Annual Report (Assessment And Prospects) makes this observation on non-food credit: "...non-food credit, inclusive of non-SLR investments, increased by over Rs 64,000 crore so far (August 9), excluding the impact of mergers since May 3, 2002 (it is not clear as to why so: these may be deemed as blips, but will be a permanent feature of the corporate landscape!), non-food credit is estimated to have increased by nearly Rs 20,000 crore; on a comparable basis, non-food credit had increased by Rs 6,000 crore last year. The expansion in non-food credit, which is widely regarded as a leading indicator of industrial activity, provides some confidence about the revival of economic growth."
But elsewhere in the Annual Report, there is this data too on advances to small scale industry. State-run banks are running less exposure to this sector as a percentage of their net credit. It has fallen to 12.5 per cent (Rs 49,743 crore) on the last reporting Friday of March 2002 from 17.5 per cent (Rs 38,109 crore) on the same day in March 1998. There is another interesting point here. In the case of state-run, the absolute number may be higher even if the percentage is lower as they run a bigger book. Again, there is no mandated target unlike the 10 per cent in the case of foreign banks. But the numbers for foreign and private banks show that these entities have done better, taken on a bigger exposure. In the case of foreign and private banks, the latest available numbers are at 14.4 per cent (Rs 8,158 crore) and 11.6 per cent (Rs 4,461 crore) from 20.6 per cent (Rs 5,849 crore) and 10.3 per cent (Rs 2,084 crore).
Where are we now Industry wants cheaper money. The authorities hope that all this will spur credit offtake. If the view coming from matured quarters is anything to go by, the story will not change. Not even the dialogues. As the RBI itself has said it its Annual report, interest rates tinkering is losing its efficacy.
So what can one expect on Tuesday Hopes of a Bank Rate cut has faded a little. A repos rate may be of 25 bps. The central bank may allow short sales of gilts. More steps towards trading of STRIPS may come through. As for those who believe that cheaper systemic liquidity will lead to a higher credit offtake, brace for this: the RBI may announce measures to strengthen the capital adequacy of banks, especially those relating to market risks.
Some Tuesdays may not cheer!