Interest rates to soften as economy starts to cool

Interest rates to soften as economy starts to cool

Mumbai: Indian companies and consumers, hit by high borrowing costs after 13 successive policy rate hikes by the Reserve Bank of India (RBI), may have reason to cheer in the New Year as the central bank embarks on monetary policy reversal.

As economic growth slows, RBI indicated in its mid-quarter policy review on 16 December that it was set to reverse its policy stance.

“From this point on, monetary policy actions are likely to reverse the cycle, responding to the risks to growth," RBI said.

Economic growth is forecast to slip to 7.5-to-7.75% in the year to next March by government estimates from the original expectation of 9%, compared with 8.6% growth in the last fiscal.

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Mint’s Dinesh Unnikrishnan says the new year will in all likelihood bring some much needed cheer for borrowers as there are indications that RBI may embark on a monetary policy reversal.

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Since March 2010, RBI has raised the reverse repo rate, at which it drains excess cash from the system, by 425 basis points (bps) and the repo rate, at which it lends to banks, by 375 bps to control inflation. One bp is one hundredth of a percentage point.

Since January, RBI has hiked its key lending rate by 225 bps, causing commercial banks to increase their lending rates by a similar margin.

On Thursday, state-run Union Bank of India cut its base rate or minimum lending rate by 10 bps to 10.65% with immediate effect.

“Given the current indications, in the first half of next fiscal, the interest rates may stabilise and may then start coming down in response to policy actions taken by RBI," said K.R. Kamath, chairman and managing director of state-run Punjab National Bank.

S. Raman, chairman and managing director of Canara Bank, agrees. “We have reached the peak (of the interest rate cycle). There is every possibility that rates will come down from now on," he said.

Inflation is likely to ease to the apex bank’s projected level of 7% by end-March, which would enable RBI to start cutting its key rates from April, says D.K. Joshi, chief economist at ratings company Crisil Ltd. Joshi says RBI is likely to cut rates by as much as 100 bps in the next year in line with the fall in the inflation rate.

“Softening inflation will create a conducive environment for RBI to start cutting rates from April," he said. “If RBI cuts rates, banks will follow. Interest rates in the system can come down sharply if inflation comes down sharply."

Major banks like the State Bank of India (SBI) and ICICI Bank Ltd have seen their minimum lending rates increase by up to 240 bps in the last one year.

The rise in borrowing costs has put loans beyond the reach of individuals and companies. According to the latest RBI data, Indian banks’ overall loan growth was a mere 7.4% so far in this fiscal year, compared with 10.9% in the same period last year. This is against an 18% loan growth projection by the apex bank.

Experts are not so confident about the central bank’s ability to control inflation by increasing policy rates.

“RBI’s ability to effectively control inflation through interest rates mechanism alone has not worked and is unlikely to work, because the primary cause of inflation is emerging from supply-side constraints," said Abizer Diwanji, head of financial services at KPMG India. “Interest rate monitoring has never been an effective way to control inflation."

Some analysts said even if RBI hikes rates further to stem inflation, banks are unlikely to pass on the burden to borrowers given the poor demand for credit. Besides, any further hike would put more pressure on the asset quality of the banks by lowering the ability of companies and individuals to pay back their debts.

“Even if RBI hikes rates now, banks will not be able to follow when the demand for loans is already low given the current high interest rates in the system," says Hatim Broachwala, analyst at Mumbai-based Fortune Financials.