Quite a few banks last week raised their loan rates. Unlike in the past, this time around, the quantum of hike is half a percentage point. This should make Reserve Bank of India (RBI) governor D. Subbarao happy as he has been harping on faster transmission of the monetary policy.
The central bank raised its policy rate on 3 May by half a percentage point. Normally, banks take time to pass on the higher cost of borrowing to consumers and there have been instances in the past when despite RBI hiking its policy rate, banks did not raise their loan rates. Apart from raising its policy rate, RBI also raised the rate of interest that banks pay to savings bank account holders by an identical margin. This has pushed up the cost of savings deposits immediately. When they raise rates on their term deposits, it takes time to feel the impact as only the new deposits earn higher rates while the existing deposits continue to be priced at old rates till they mature.
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While the industry’s savings account portfolio is roughly about 22% of the overall deposit kitty, the impact on individual bank’s cost varies between 10 basis points (bps) and 15 bps, depending on their composition of deposits. One basis point is one-hundredth of a percentage point. This apart, higher provision requirement for bad loans and restructured loans will also affect banks as they need to set aside more money for such assets. The combination of all three—a hike in policy rate, savings rate as well as higher provision of bad assets—has made money more expensive and banks have no choice but to raise loan rates instantly. Following this, their loan growth will probably slow and quality of assets, too, may deteriorate as some firms may find it difficult to service higher interest cost. The Indian banking industry’s loan book grew 21.4% in fiscal 2011, higher than RBI’s projection of 20% growth. In 2012, RBI wants banks’ credit growth to be 19%. A drop in credit growth will bring down banks’ interest income and, on top of that, if their bad assets grow, they will have to set aside more money to provide for them. This will affect their profitability unless they find ways to bring down their cost of operation and become extra-sensitive to the quality of assets. This means a close monitoring of all loan accounts and a very strict appraisal of new loan proposals. They can earn high interest rate from a loan given to a relatively weak corporation but such an exposure runs the risk of loan default. If that happens, a bank not only stops earning interest on that loan but also is required to set aside money for such an asset.
RBI allows banks to restructure bad loans (so that they do not need to provide for them) when there is an economic downturn but no such concession is given when loans turn bad because of indiscreet lending. So 2012 could be a year of conservative banking with a hawk eye on quality of assets, operating cost and fee income.
The impact of the policy rate hike is sharper on short-term money. For instance, the yield on 10-year benchmark government bond rose from 8.14% on 2 May, a day before the announcement of monetary policy, to 8.25% on 5 May, but the three-month treasury bill yield, during this time, moved from 7.52% to 7.95%, and that of one-year treasury bill from 7.76% to 8.20%. Bond yields dropped on Friday, 6 May, as a sharp fall in commodity prices encouraged the market to bet on a lower inflation. The price of crude dropped around 12% last week. A bond auction on Friday, the first after the policy rate hike, saw good demand from buyers and no dramatic change in yields.
This is good news for the government as there will not be any drastic rise in its cost of borrowing. The Indian government plans to borrow Rs 2.5 trillion from the market in the first six months of the fiscal year till September, 60% of its Rs 4.17 trillion annual borrowing programme. The February budget has pegged the government fiscal deficit for the year at 4.6%, and the money raised from the market will bridge the gap.
Analysts are sceptical about the fiscal deficit target as the budget has not made adequate provision for crude oil, fertilizer and food subsidies, and a lot will depend on the crude price movement. For the time being, though, the government is tiding over its short-term cash mismatches by raising money through cash management bills.
It raised Rs 32,000 crore in the first five weeks of the fiscal year through such bills and also raised the size of weekly treasury bill auctions. This extra borrowing has, however, got nothing to do with fiscal slippage. It’s just to take care of cash mismatches due to changes in the government’s spending pattern. It is making income tax refund faster to corporations, which, till recently, used to take around six months. Indian firms pay advance tax every quarter on their projected profits and in case the payment turns out to be higher than what they should have paid, the government refunds the difference.
RBI will have wholesale price inflation data of April and May, and factory output data of March and April, apart from the gross domestic product figure for the January-March quarter to look at before taking a call on yet another rate hike when it announces its mid-quarter review of monetary policy in mid-June. Of all these, the most critical data to watch out for is non-food manufacturing inflation, which rose to a two-and-a-half-year high of 7.1% in March. The policy rate will probably be kept at a higher level than non-food manufacturing inflation.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email your comments to firstname.lastname@example.org