Matters Of Interest

For the first time after 1992, bank stocks have joined the stock-market rally, gaininghandsomely on expectations of a profit boost through the bank rate cut. In a synchronisedsequel to Budget 1999-2000, the RBI cut the bank rate by a percentage point to 8 per centand repo rate by a sharp two points a day after the budget. To top what now seems acoherent package to boost capital markets and buoy investment sentiment, the central bankalso dropped banks’ cash reserve ratios (CRR) from 11 to 10.5 per cent.

The stage is now set for an across-the-board cut in interest rates to putmore cash in the hands of enterprising businessmen. The cut in CRR alone will release Rs3,500 crore into the system. Says State Bank of India (SBI) chairman G.G. Vaidya:"Already, there have been signs of credit picking up. I am sure the credit offtakewill grow manifold in the last month of the current fiscal and the first quarter of1999-2000."

Justifying the cuts, RBI governor Bimal Jalan said: "Somemonths ago, I had already indicated preference, along with many others, for lower interestrates, provided the conditions were right. In view of lower inflation in recent weeks,slow credit offtake and the next year’s lower borrowing programme announced by thegovernment in the budget, the RBI’s judgement now is that conditions are right forsuch a move. In one stroke, Jalan gave banks more than they ever expected. The cut in bankand repo rates were due so as to bring about an internal realignment but the CRR cut, saysShailendra Bhandari, executive director of HDFC Bank, "came as a pleasant surprise.Even the magnitude of the cuts were unexpected".

On cue, most state-run banks cut their PLRs. SBI has dropped its long-and medium-term prime lending rates (PLRs) to 12 per cent, from 13 and 12.75 per centrespectively, and Bank of India has fixed it at 12 per cent from 13 and 12.90 per cent.Bank of Baroda (BoB) now offers 12 per cent and Union Bank, Central Bank and Dena Bank areexpected to follow suit. And if lending rates drop, can deposit rates be far behind?"While a deposit rate cut will hit growth of deposits, the money so released mightwell flow into the stockmarkets or consumer goods," says a banker.

Bankers also feel that the rate cuts might lead to a small depreciationin the rupee. "If the rupee dips slightly, exports might well pick up. It will belike icing on the cake," says a senior SBI official. Adds A. Ravi Kumar, chief forexdealer at ABN Amro Bank: "This can be taken as a signal that the RBI is comfortablewith a weaker rupee."

But many take a more cautious tone. Says a senior economist: "Theinterest rate cut may not do all that much unless the credit delivery systemimproves." Echoes BoB chairman K. Kannan: "I am not very sure whether a onepercentage point cut in the bank rate will enthuse corporates to lift credit. But it willhelp banks improve the quality of their assets. The interest rate burden on corporateswill be reduced and naturally the number of defaulters will come down." As a result,SBI, BoB, HDFC Bank and Corporation Bank all posted 7 to 8 per cent rises in their sharevalues.

The rate cut is expected to soften the negative impact of a tax-raising,expenditure-freezing budget on aggregate demand. The inherent risk in that is, of course,inflation. Says Ashok Lahiri, economist and director of the National Institute of PublicFinance and Policy: "I am not in favour of interest rate cuts. Inflation is still toohigh. And high inflation hits exports by affecting the value of the rupee. Also, loweringinterest rates means penalising the savers, not the borrowers who ought to pay the pricefor scarce capital."

Adds Gopal Jain, president of VLS Finance: "Interest rate cuts in thepast haven’t helped because the government remains a strong contender for funds. Andit will remain so since the budget assumes a best-case scenario—an 8 per cent-plusindustrial growth. It’s diffi-cult to believe that government expenditure, which grewby 8 per cent last year, will rise by only one per cent in 1999-2000." Indeed, a moreeffective trigger to economic expansion and in turn, growth, would have been a lowerfiscal deficit, which would have happened only with a sharply reduced governmentborrowing.

Sums up an economist at DSP Merrill Lynch: "How far interest ratesdrop depends on the level of monetary accommodation of government borrowings and whetherthe borrowings stay within the budgeted level. The central bank has already warned thatbroad money supply is growing too fast for comfort and may opt for a lower level ofmonetisation this year."