When they say that interest rates are about to go up
Over the last few weeks i have seen comments from various senior officials of both PSU and Private sector banks commenting on the direction of interest rates and saying that interest rates are likely to move up over the next six months. I am sorry to say that I believe these people are totally out of sync with the reality of the entire situation. There is no way interest rates for consumers and corporates are likely to move up anytime soon. Infact most of the banks that have been making noises on potential increase in interest rates are themselves actually cutting rates on auto, housing, consumer etc loans.
Real interest rates in India continue to be among the highest in the world and given the fact that commodity prices in my view are now more near their peaks rather than their bottoms, projection of inflation based on current commodity prices are unlikely to come true. Despite short term rates falling sharply the rate of interest on various kinds of loans have been very sticks and the decline in rates has been in the region of just about 150 to 200 basis points rather than the expected 300-400 basis points. Under the circumstances expecting an upturn in rates is not a realistic assumption. The reasons for my view are as follows –
Short term interest rates continue to be low with the RBI continuing to get over Rs 100,000 crores every day in the reverse repo window at 3.25 percent. This will ultimately start hurting banks who have been trying to hold rates at higher levels. Working capital loans for most corporates still continues to be higher than 11% and this kind of spread is unlikely to last much longer. As the confidence on economic recovery gains strength spreads will come down and lead to a decline in revolving credits. Banks are able to raise bulk CD’s at rates below 5%, as such these spreads are abnormal in my view.
Credit growth continues to be sluggish – Due to a combination of economic slowdown, better working capital management, easier liquidity outside the banking system, general cautiousness etc the credit growth for the Fortnight ended August 14th has fallen below 15%. Total deposits continue to grow at a rate of 22%. Under the circumstances the liquidity in the banking system is further going up. This will force the banks to reduce rates sooner than later. Most bankers are still expecting that they can rip off consumers during the forthcoming festival season by giving loans at higher rates. However given the fact that there are a huge number of banks one by one they will blink and reduce rates as on each incremental addition to deposits they are making losses. The credit deposit ratio has also come down below 70%.
High cost deposits raised during September-November 2008 are now coming for renewal. A large number of banks raised money at double digit rates last year in this time period. Also CD’s were raised at very high rates during this time period. These deposits will now get repriced atleast 400-500 basis points lower. This will reduce the cost of funds for the banking system as a whole and will lead them to cutting rates. We have seen ICICI bank reducing rates on housing loans substantially today as they will be the key beneficiary of deposit repricing over the next few weeks.
Liquidity with NBFC’s is improving – With reducing bulk rates and falling risk aversion NBFC fund raising has become easier and most of the NBFC’s that were cutting down on loans are now looking to expand their loan book. This will also bring about a competing segment for banks and pressurise them to reduce rates.
Capital flows are improving and likely to accelerate – Foreign capital flows after seeing a strong outflow in the year 2008 specially on the FII front have already seen an inflow of over USD 7 billion for the current year. With a large number of IPO’s and QIP’s being floated money flow through the direct equity route is also likely to improve. A number of companies have also been able to raise GDR’s. Fund raising for this year has already crossed nearly Rs 40,000 crores. This is equivalent to around 1.5% of total bank credit in a very short period of time after a total absence of fund raising in the 15 month period from January 2008 to March 2009. Strong capital flows will further keep liquidity strong in the system and companies will continue to raise equity funding as long as debt funding costs remain stubbornly high.
Given the fact that dollar 3 month LIBOR costs have come down to 0.4%, external fund raising even at the currently elevated spreads and inclusive of the cost of hedging is significantly cheaper than domestic borrowing. Spreads are likely to reduce over the next six months as confidence comes back over the global recovery and liquidity continues to be strong. External borrowing are likley to pick up in a big way going forward and will further put pressure on domestic interest rates.
Trade balance continues to improve despite a fall in both exports and imports, the overall trade balance is only improving. High trade balance is essentially an export of liquidity out of the country and as such a reduction of the same is also positive for improving liquidity and lowering rates.
The only reason being given for rates to move up is higher government borrowings, however i believe that this is more than factored in and is known to all market participants. As the government completes a large part of its borrowings by September yields and borrowing costs are more likely to fall than rise in the second half of the current year.
As such I would bet on a 100-200 basis points reduction in consumer and corporate loans rates over the next six months.