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An interest rate blunder

An interest rate blunder
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First Published: Wed, Jul 02 2008. 12 49 AM IST
Updated: Wed, Jul 02 2008. 12 49 AM IST
Let there be no doubt: Interest rates are going up.A large number of public and private sector banks have already announced increases in their lending and deposit rates over the past few days. These moves are in response to the Reserve Bank of India (RBI) decision last week to push up the cost of money. The central bank hiked one of its key policy rates and tried to restrict the ability of banks to lend by increasing the cash reserve ratio (CRR).
Various categories of borrowers — both corporate and individual — will want to know whether banks will push up rates further. The answer to this question, obviously, depends on what RBI will do over the next few months in its battle against inflation. But, there is another factor that also needs to be considered.
Let’s go back to re-examine what happened in January. The central bank was already busy sending out stiff warnings about the incipient threat from inflation. Many economists, too, were veering around to the view that Indian monetary policy would have to be eventually tightened.
And what did banks do? In a moment of sheer insanity, the largest public sector banks turned their backs on economic reality and actually cut lending rates.
The finance ministry goaded them on. “I would like, I can’t wish this, that banks cut lending and deposit rates by 50 basis points so that it stimulates investment and consumption,” said finance minister P. Chidambaram on 4 January. This was at a time when the government was in a totally different frame of mind, dismissing inflation as the doing of commodity speculators and profiteering cartels in steel and cement.
The logic of these sudden interest rate cuts escaped us even then. Anyway, what this means is that by the middle of June, lending rates were around 50 basis points lower than what they should have been. The current round of rate hikes is then just a move back to the status quo of early 2008. Banks have merely undone that silly decision. They have not yet taken the recent monetary tightening by RBI into account.
So, while, at first glance, the announced interest rate hikes seem suitably hefty, they are actually far too inadequate.
Did banks err by cutting rates earlier this year? And will they thus have to take tougher decisions now? Write to us at views@livemint.com
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First Published: Wed, Jul 02 2008. 12 49 AM IST