Mumbai: The expected has happened. Only the timing was unexpected. The Reserve Bank of India (RBI) has raised the reverse repo and repo rates by 0.25% each.
The central bank has pointed out that food price inflation, despite some moderation in the last few weeks, remains at an elevated 16%; the consumer price indices have been rising in recent months.
Interesting times: Chetan Ahya (left) and M.D. Mallya. Abhijit Bhatlekar / Mint
But the most dramatic shift, according to RBI, has been in the non-food manufacturing index. The inflation in this category has risen from -0.4% in November to 0.7% in December to 2.8% in January and 4.3% in February.
Bank of Baroda chairman M.D. Mallya; Chetan Ahya, economist at Morgan Stanley; and Nomura Holdings Inc.’s managing director and fixed income co-head Neeraj Gambhir speak about the RBI move and its impact. Edited excerpts:
What is going to be the immediate reaction from banks? Will they be raising any rates at all?
Mallya: I would say RBI has given a signal that interest rates are hardening. I think this was expected. We were expecting an increase (of) between 25-50 basis points in repo and reverse repo rates. That is what RBI has done: 25 basis point increase in both repo and reverse repo. (One basis point is one-hundredth of a percentage point.)
But then looking at the current liquidity in the system, which is quite strong and the fact that credit pick-up still remains slightly muted, I don’t think immediately there is any necessity for increasing lending rates. Perhaps at best the sub-PLR (prime lending rates) rates could get slightly re-adjusted on the higher side. But otherwise I think at this point in time, there is no likelihood of any increase in (bank) interest rates.
You have long maintained that RBI is way behind the curve in terms of the inflation numbers and the growth numbers and the signaling rate at 3.25%. Would you say that April will be a sure-shot repeat of what RBI has done on Friday?
Ahya: I would think so. If (non-food inflation)...goes up to something like 8% in March, (figures for) which will be released on 15 April, then we would not even rule out them doing 50 basis points. But I will say that right now the base case is 25 basis points repeating on 20 April (in the RBI’s annual policy review).
What would you expect?
Gambhir: I agree with Ahya. This is just bringing forward what was to be written in the April policy given the fact that the inflation print was slightly higher than what they had expected. They have just tried to bring it down a little bit further. There is a strong possibility of (a) further 25 basis points increase in both repo and reverse repo rates.
Liquidity in the system is high and is expected to continue to remain high in April as well. So, some action on the CRR (cash reserve ratio, the portion of deposits banks are required to keep with RBI) front can also not be ruled out.
The only issue on the CRR front is the (Union government) borrowing programme starting in April. They need to make sure that the system is liquid enough for them to support the borrowing programme.
If another hike takes place in the reverse repo and repo rates in April, will you be moving your lending rates in April?
Mallya: Perhaps RBI could do a calibrated increase in both the repo and reverse repo rates. Our earlier expectation was 25-50 basis points, therefore the likelihood of RBI further increasing by another 25 basis points in the April policy may not be ruled out.
Unless there is a strong pick-up of credit and unless the liquidity overhang, which still persists in the system, gets consumed, I don’t think there is any possibility of increase in lending rates. Going forward, we need to very cautiously observe the macro-economic fundamentals which are likely to impact the overall situation.
Do you think anything changes on the growth scenario since most of the rates are not going to get priced in immediately?
Ahya: Certainly not. We should understand that monetary policy always impacts with a lag. This is the reason why we were making noises that RBI needs to move quickly because the current data points and current inflation numbers are already very high.
If we don’t act now, then the future credit growth is going to go way past 25% and cause a big tightening in liquidity automatically, which will mean that we are basically lagging in terms of acting on policy rates.
When do you think bank interest rates will rise? Do you think it will happen only in the second half?
Mallya: I would say for the next four-five months (we will see) stable rates with a sort of a hardening interest rate bias. Going forward, maybe towards the second half of the current fiscal, there could be a slight hardening of rates to corporates and retail as well. But then all this depends on how exactly the credit pick-up is likely to be.
Industrial production numbers have been strong. We have seen the revival of at least a few segments of industry. If the trend continues, my expectation is that growth in FY11 could be much better in terms of credit pick-up and delivery.
If we assume that in the current fiscal..., the overall credit growth for the system is in a range of around 15-16% as estimated at this point in time, then the next year growth could be at least in the range of around 19-20%.
It also supports the view that in case GDP (gross domestic product) growth is likely to be in the range of around 7-7.5%, one could always expect a credit pick-up of around 20%. If that were to happen and liquidity were to be absorbed, perhaps there is a case for (an) increase in the lending rates. Otherwise, it would be difficult to guess at this point in time.
Do you think you will have to wait up until the second half of the next fiscal year, i.e., September, for rates to rise or do you think credit growth will be much faster?
Ahya: Absolutely. Credit growth will pick up much faster. But the way industrial production is going, credit growth tends to lag industrial production by 4-6 months. Credit growth is bound to shoot up, and I would not be surprised if the March number itself will be 18% year-on-year (YoY).
So, we will soon be crossing 20% and deposit growth is at 16-17%. We will be utilizing a lot of this excess liquidity and the public sector banks will be seen doing lending rate hikes in two-three months’ time.
How does all this affect the economy?
Gambhir: The current round of increases by the central bank is not actually a monetary tightening. It is what we would call policy normalization. We were at a reverse repo and repo rate of about 3.5% and thereabouts and are actually inching towards 5%...
So, it is not a policy tightening. It is not being designed to constrain the growth in the economy. It is being designed to make sure that the inflationary pressures are taken care of. More of future inflationary pressures are taken care of, so I do not think the idea here is to constrain growth.
There will be an upward impact on interest rates. The most important thing for us to watch is the way the government bond yield curves settles, which is currently in the ballpark of 8%. We were about 7.90%, a shade lower than 7.90%, before this rate hike happened.
In the first half of next year, there is a front-loaded government borrowing calendar. So, we could potentially see a 10-year government bond rated about 8.5% or so. If you benchmark against that, the private sector borrowers and the lower-rated borrowers have to pay somewhat higher. We could potentially be in the region of double digits for these borrowers if the pressure on the rates is going to come a little bit more from the government borrowing side rather than just the liquidity and the Reserve Bank action point of view.
But given the global liquidity, the industry will not have too much of a problem?
Gambhir: We are in a very unique situation right now. Till about 10 years ago, it was only the Japanese economy which used to provide low-cost liquidity for the world. Now, we have at least two—Japan and US. We have a far higher availability of low-cost liquidity and cheaper sort of funding available in the world.
Given the availability of funding for the Indian economy, I would expect this should not be a big constraint.
Clearly it does not look like the industry is going to be very seriously affected, except perhaps the small and medium enterprise sector later in the year. Will retail credit will fall? Do you think consumption will fall at all by the end of FY11?
Ahya: Consumption will definitely moderate in the second half when the rate hikes will get meaningful. But the numbers are just way too robust. Current accounts, savings accounts are growing at 40%. If they moderate down to 20%, that is not really an issue.
We will have alternate growth engines coming up. Exports recovery is happening. We will see investments picking up. All in all, growth should still be holding up pretty well.