The starter’s gun for banks to increase their lending rates has stopped them for quite some time now. State Bank of India (SBI) was the first to remain closed. Our leading commercial lender increased its marginal cost of funds-based interest charge by 10 basis points (one basis point is one-hundredth of a percentage point). Soon, three other big 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 the public sector banks which usually follow the signals of SBI. While the growth is indeed important, the underlying message assumes even greater significance: SBI’s marginal lending rate is indexed to the cost of its liabilities, which cover depositors as well as other borrowings (such as bonds). It then sets off something that has so far remained in the realm of speculation: the cost of funds for all financial intermediaries in the country has been creeping up, despite the Reserve Bank of India’s (RBI) easing currency policy.
In the absence of a clear central bank signal, a hike in their lending rates by banks can be seen as the ability of the RBI to influence the sector without cranking up its core policy rate. As of late, the central bank has been quietly signaling the need for a bounce. Its variable rate reverse repo auctions have seen cut-offs closer to the 4% repo rate (whereas the fixed-rate reverse repo window offers 3.35%), hence the need for higher charges on the money lent to market participants. Will feel In April, the RBI included a new permanent facility for clean deposits without any collateral, at a rate higher than that provided on ‘reverse repurchase’ of government bonds. Gilt yields rose in response, setting up a pace rate hike by lenders.
The sequence of interest rates from here is both obvious and confusing. It is clear that they will be on an upswing in lending categories, risk buckets and duration, but the extent and frequency of these increases will depend on a variety of variables, all shrouded in uncertainty right now. One of them is high inflation which has defied RBI’s estimates. Higher price-level expectations seem to have begun and the layoffs will now require decisive RBI rate action. The second factor will be the government’s 15-trillion gross borrowing programme, of which 60% is earmarked for the first half of 2022-23. The third factor, related to the second, would be the success of the government’s disinvestment plan, which would reduce the pressure on its fiscal deficit. Fourth, the extent to which the rupee can be protected from external pressure; RBI’s forex reserves are down $2 billion and some of it may have gone to protect the rupee from a sharp fall. In a rising rate environment, the behavior of private sector capital expenditure – a new appetite for which was on display – will be critical to employment, income generation and overall economic growth. Rising rates are also likely to revive the ghost of non-performing assets, which were brushed under the carpet during the pandemic. It is difficult to predict how much the rates will increase. But given that inflation can act as a covert tool for real debt reduction, fiscal and monetary authorities should completely re-commit themselves to price stability. Since it won’t be easy at this stage, it’s time for us to tighten the belt. Tough times are coming for the economy.