With State Bank of India (SBI) raising interest rates on one-year retail deposits by 15 basis points, to 6.4%, the rate cycle appears to have turned decisively. SBI, along with a few other banks, has already increased its Marginal Cost of Funds Rate (MCLR), and others could soon follow suit. Credit growth has been averaging 10% over the past couple of months, and while for some part this comes off a very low base due to demonetisation in 2016, bankers say demand for working capital is picking up.
Bond yields, of course, have remained elevated for some time now—the benchmark yield currently is 7.73%, up by 70 basis points in the last three months. The markets have been spooked by fears that inflation could rise, especially on two counts: the government’s plan to support prices of crops if farmers are unable to earn the MSP and a shortfall in GST collections. Both these, the bond markets believe, would lead to a slippage in the fiscal deficit, compelling the government to borrow more.
While economists believe inflation could moderate towards the second half of 2018, allowing RBI to hold the key policy rate and banks to not increase lending rates, they too are apprehensive inflation may be higher than estimated if farmers are remunerated to the extent of 1.5 times the production cost. As a result, Nomura estimates kharif MSP growth will double, to nearly 13% in FY19 from 6% in FY18. This is likely to be inflationary—even if it is a one-time shock—driving up food inflation and, consequently, the CPI to which the central bank benchmarks the policy rate. Economists point out that, traditionally, elevated MSP increases have preceded inflationary pressures. The second big concern is the GST collections, which have averaged `87,854 crore between July 2017 and January 2018. Unless the compliance gets better soon, the budgeted target might not be met.
It is a tough call for the government which clearly wants a big financial outlay for rural India in a pre-election year, but doesn’t want to be too fiscally imprudent either. Hopefully, the large rural spends will result in a boost to consumption and come back to the government by way of indirect taxes. However, there is little doubt higher loan rates for companies and individuals could be a dampener at a time when corporate India is still coming out of a tough period post the GST rollout and demonetisation. The government should try and mobilise as much of its resources from extra budgetary sources so as not to crowd out the private sector.