Opinion Credit isnt due
In the short term,you might not notice. But the days of cheap money are at an end....
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The Reserve Bank of India (RBI) has made money more expensive and is also trying to drain some of it out of the system. As part of its monetary policy measures,the central bank has upped the key policy rates the repo and reverse repo rates by 25 basis points each to 5.25 per cent and 3.75 per cent respectively. At the same time,it is also flushing out Rs 12,500 crore out of the system,through a 25 basis point increase in the Cash Reserve Ratio,or CRR,to six per cent. The RBIs reasons are clear: it needs to tame the rise in prices which is becoming worrisome,with wholesale inflation nudging 10 per cent in March against the RBIs baseline projection of 8.5 per cent. Inflationary pressures,the RBI says,have increased since January and have become more generalised,Whats important is that wholesale inflation is no longer driven by supply side factors alone; in other words its not just a shortage of goods thats responsible for prices moving up sharply,but also increasing demand on the part of consumers.
The RBI can afford to make money costlier right now because the economy is growing at a fairly fast clip. While factory output for February may have come in a tad lower,at 15.1 per cent year-on-year compared with a more robust 16.7 per cent in January,its nonetheless good growth. Governor Duvvuri Subba Rao says the recovery is consolidating and is confident that the economy will grow at eight per cent this year with an upside bias. So,its obviously confident there is no immediate danger of growth being stymied by money becoming dearer.
To be sure,there is enough money with banks today because neither individuals nor companies are really rushing to take loans; while companies have been able to access the equity markets and are also seeing improved cash flows,small borrowers have been hurt by the high inflation,including high food inflation.Thats why banks are unlikely to increase interest rates on loans immediately,whether for big or small borrowers. Indeed the competition for some products such as home loans is so fierce that even big players are afraid of being priced out of the market. Although their cost of funds will go up,partly because of the higher CRR,partly because of the new method of calculating the interest rate on savings accounts and partly because theyre beginning to pay customers more for term deposits,banks are unlikely to pass on this cost to customers immediately and may instead opt to take a small hit on their margins.
However,this situation may last,at best,for another three to four months,till the available money in the system starts getting used up. Some of the money will be mopped up by the government,whose borrowings this year are about 36 per cent more than they were last year. Also,the demand for credit from companies will pick up as they become more confident about expanding their businesses and add to their capacities. In the meanwhile,it is possible that interest rates will move up further,since inflation is unlikely to come down in a hurry though it could peak by around June. (Thats if the monsoon turns out to be normal and we have a good harvest; otherwise food inflation may remain high.) In any case,its widely expected that the RBI will increase policy rates by at least another 75 basis points between now and March 2011 as it tries to rein in inflation.
The yield on the ten-year bond,which is the benchmark for interest rates in the system,is already at eight per cent and is expected to move up to 8.5 per cent by the end of the year mainly because the large quantum of government borrowings is expected to leave less money for companies in the private sector. In fact,Governor Subba Rao himself says that the crowding out of the private sector could exert pressure on interest rates. If that happens then banks will slowly start increasing rates for customers,because they will also be borrowing at higher costs,and cannot afford to hurt their margins beyond a point. So consumers will end up paying more for car loans and home loans while companies will have to fork out more for both working capital and term loans. The days of cheap money are soon going to end.
The writer is Mumbai Resident Editor of The Financial Express
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