BackWe face rising rates fed by a shaky set of factors
Lending rates have begun to rise, nudged up partly by recent RBI actions, but other clouded variables make the extent and pace of their course unpredictable. Inflation, for example
PremiumThe starter’s gun has gone off for banks to increase their lending rates, having held them down for quite some time now. State Bank of India (SBI) was first off the block. Our leading commercial lender raised its marginal cost of funds-based interest charge by 10 basis points (a basis point is one hundredth of a percent). Soon, three other large banks—Bank of Baroda, Kotak Mahindra Bank and Axis Bank—followed suit. It can be safely assumed that many other banks will start raising their lending rates, especially public sector banks that usually follow SBI’s cues. While the hike is indeed significant, the underlying message assumes even more significance: SBI’s marginal lending rate is indexed to its cost of liabilities, which includes funds from depositors as well as other borrowings (such as bonds). This then settles something that has existed in the realm of speculation so far: the cost of funds has been creeping up for all financial intermediaries in the country, despite the Reserve Bank of India’s (RBI) easy money policy.
A succession of banks raising their lending rates in the absence of an explicit central bank signal could be viewed as RBI’s ability to influence the sector without cranking up its main policy rate. Of late, the central bank has quietly been signalling the need for a bump-up. Its variable rate reverse repo auctions have seen cut-offs tacking close to the 4% repo rate (whereas the fixed-rate reverse repo window offers 3.35%), so market participants would have sensed a need for higher charges on the money they lend. In April, RBI inserted a new standing facility for clean deposits—with no collateral—at a rate higher than it offers on ‘reverse repurchases’ of government bonds. Gilt yields shot up in response, setting in motion rate hikes by lenders.
The course of interest rates from here on is both clear and confusing. It is evident that they will be on an incline across lending categories, risk buckets and tenors, but the extent and frequency of these increases will depend on a variety of variables, all clouded by uncertainty right now. One of them is high inflation that has defied RBI projections. Higher price-level expectations seem to have set in and will now require decisive RBI rate action to retrench. The second factor will be the government’s ₹15-trillion gross borrowing programme, 60% of which is scheduled for the first half of 2022-23. The third factor, related to the second, will be the success of the government’s disinvestment plan, which would ease pressure on its fiscal deficit. The fourth will be the extent to which the rupee can be secured against external stress; RBI’s foreign currency reserves are down $2 billion and some of it would have gone to defend the rupee from sharp drops. In a rising rate environment, the behaviour of private sector capital expenditure—a renewed appetite for which was on display—would be critical for employment, income generation and overall economic growth. Rising rates are also likely to revive the spectre of non-performing assets, which had been brushed under the carpet during the pandemic. How high rates will go is hard to guess. But given that inflation can act as a covert tool for real debt reduction, fiscal and monetary authorities must recommit themselves squarely to price stability. As this won’t be easy at this stage, it’s time for us to tighten belts. Tough times lie ahead for the economy.
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