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Policy Prop For Sentiments

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If you cannot cycle, recycle. At least it gives a sense of momentum. And that is exactly what the Reserve Bank of India (RBI) sought to do on Tuesday when it cut both the reverse repo rate and repo rate by 25 basis points (bps) each to 3.25 per cent and 4.75 per cent, respectively. But will banks cut their lending rates? And more importantly, will they be inclined to expand lending in a big way at lower rates? Unlikely.

Systemic liquidity does not mean that banks will lend. It does not quite work that way. “The RBI has ensured that liquidity is not an issue,” says Roopa Kudva, managing director and chief executive officer of Crisil. Risk perceptions have changed. In the financial year 2008-09, Crisil downgraded 84 firms, upgraded just two.

Take commercial credit — it grew by 17.5 per cent on a year-on-year basis at March end 2009, down from the 29.4 per cent in October 2008. It needs to be qualified here that credit growth was high in the first six months of fiscal 2008-09 as there was just one watering hole — banks — as external sources of credit dried up. Then, oil marketing companies mopped up Rs 36,208 crore during this period compared to a decline of Rs 1,146 crore in the corresponding period of the previous fiscal.

The RBI is using every form of moral suasion to get banks to drop lending rates. During the second half of 2008-09, RBI cut the repo rate by 400 bps, while banks have lowered their lending rates in the range of 50-150 bps — it now ranges between 11.50 and 15.75 per cent. The central bank painfully points out that current deposit and lending rates are higher than in 2004-07 when policy rates were lower.

Few bankers are ready to go on record and state that they will lend in a markedly different manner. Chanda Kochhar, CEO-designate at ICICI Bank, says that rate cuts “signal the continuation of a supportive interest rate regime in the economy”.

Rana Kapoor, managing director and CEO at Yes Bank, feels that the near-term challenge lies on the demand side — private sector credit demand is still subdued. “Sentiment needs to improve and translate into higher credit demand before any meaningful turnaround can be visible,” he says.

Robert Prior-Wandersforde, senior Asian economist at HSBC, is blunt: “The rate cut is a compromise move. Maybe RBI was reluctant to do more given that the general election is now underway. But the fact that it did anything at all indicates that the growth outlook remains of greater concern than inflation.” He adds that the recent improvement in motor vehicles sales has more to do with the public sector pay rises than interest rates and could well prove to be temporary.

Performance of banks in 2008-09 will be a key pointer to their risk appetite. Macquarie Research in a recent report on the banking sector says the dramatic slowdown in the economy from October-November 2008 has increased stressed assets. “We think the softest spots are export-oriented businesses, commodity manufacturers, infrastructure operators and property. The key drivers for defaults are likely to be excess leverage, acute demand destruction and incomplete projects,” the report says. The RBI, for its part, has allowed banks to postpone recognition of losses on any loans that have gone into restructuring before March end 2009. Bottom line: expect more bad news.

Some banks have already responded to the RBI’s call: ICICI Bank has dropped its lending rates by half a percentage point. Others are more circumspect about making a similar announcement. Chances are that most public sector banks may not have any choice.

(Businessworld Issue Dated 27 April-04 May 2009)