Companies and individuals will have to pay more on borrowings with India’s central bank raising its key short-term lending rate by 25 basis points to 7.5%. Reserve Bank of India governor Y.V. Reddy also announced measures to check flow of credit to real estate, capital markets, and some personal loan segments during his review of the credit policy on Wednesday. By increasing the safety cushion needed to lend, RBI has made it more expensive for banks to issue such loans.
The measures should help reduce inflation, which was at 6.1% in the second week of January, its highest in two years. In October 2006, RBI had warned against “the dangers of possible overheating” a reference to growth resulting in inflation.
Reddy revised the bank’s estimate for economic growth in 2006-07 from 8% to 9%. On Wednesday the Central Statistical Organization also revised its calculation of GDP growth in 2005-06 to 9.1% from 8.4%, on the back of a 6% growth in agriculture. Since growth is calculated year-on-year, this makes it difficult for the agriculture sector to show growth this year.
Reddy has warned that he would use all instruments to fight overheating, including hiking the cash reserve ratio of banks, which defines the minimum amount of reserves a bank must hold, from 5.5%.
Reacting to the governor’s policy, the chief executive of a private bank said, on condition of anonymity, that “banks will need to allocate more capital to lend to these sectors and in the absence of that, there could be a slowdown in credit growth.” However, Chanda Kochhar, deputy managing director of ICICI Bank does not see demand slowing. “Credit demand is growing and the rates will go up,” she said.
Bankers also saw enough signs in the policy document that the central bank may soon increase rates again. “I have never seen a more hawkish policy before,” said Nitin Jain, the chief of fixed income securities at ICICI Securities. AK Khandelwal, the chief executive of Bank of Baroda, said there would be an immediate pressure on deposit rates. By reducing the interest rate on deposits by Non Resident Indians, the central bank may be forcing banks into raising interest rates on domestic deposits. NRI deposits in the banking system in October 2006 added up to Rs 37,000 crore. “Banks will have to raise their deposit rates to attract resources to support the credit growth,” said a foreign banker.
The banking system’s credit portfolio grew at 31.2% year on year as on 5 January, 2007 on top of an identical growth a year ago and retail loans constituted over 49% of the total credit growth. RBI wants to stop this trend.