Saturday, March 31, 2007
India's largest private sector bank ICICI on Saturday hiked its floating reference rate by one per cent for consumer loans, including home loans, with effect from March 31.
It also announced an increase of one per cent in its Benchmark Advance Rate, a release here stated.
The revised FRR will be 12.75 per cent per annum as against 11.75 per cent at present and the revised I-BAR will be 15.75 per cent per annum payable monthly as against 14.75 per cent at present.
For existing floating rate customers, the increase in FRR by one per cent will be effective from April 1, 2007.
Existing fixed rate customers, whose loans are fully disbursed, will, however, not be impacted by the increase and their contracted rates will remain unchanged, the bank stated.
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In a stylised mock charge on "inflationary expectations", the RBI on Wednesday marked up the cost of money it lends to banks against securities under repo by 25 basis points to 7.50 per cent. At the same time, it lifted growth projections for the current fiscal to 8.5-9 per cent over its last estimate of 8 per cent. All other key markers were left unchanged by the RBI as a springtime offer to the economy.
To contain "sharp increases in asset prices as well as greater volatility in financial markets", the RBI Governor, Dr Yaga Venugopal Reddy, has raised provisioning on standard assets against loans to the real estate sector, outstanding credit card receivables, loans and advances qualifying as capital market exposure and personal loans to two per cent from one per cent. Provisioning for loans to housing, agriculture, SMEs and industry remain unchanged.
Banks will have to provide two per cent (existing 0.4 per cent) on exposures in standard assets to non-deposit taking NBFCs while the risk weight goes up to 125 per cent from 100 per cent.
At a press conference, the RBI Governor said the focus was on price stability and credit quality. The Deputy Governor, Dr Rakesh Mohan, added RBI would not hesitate to use all policy instruments, including CRR, to manage liquidity. Bankers may wait a while, having chalked up deposit and lending rates in recent months.
The Third Quarter Review of Annual Statement on Monetary Policy for 2006-07 wants to douse "inflationary expectations" by sticking to the 5-5.5 per cent band. If over the last two years, soaring crude prices pushed RBI to make money dear, today there is concern over the uneven farm performance.
Industry and services sector are growing at a hopping pace while agriculture growth "has not been as sanguine" with output dropping in the first half of 2006-07 over that a year ago. Supply-side pressures due to "declines in the production of rice, coarse cereals, oilseeds, pulses and cotton have emerged as a source of concern for the near-term outlook, especially in view of the relatively low levels of food stocks," says the RBI.
Foreign deposits are being discouraged with interest rate ceilings on NRE and FCNR(B) deposits being pruned by 50 and 25 basis points respectively. Also, banks have been prohibited from granting fresh loans in excess of Rs 20 lakh against these deposits.
Task at hand
Yet that leaves RBI with the trying job of ring fencing the impact of dollar inflows with net accretion to forex reserves (excluding valuation changes) being $ 8.6 billion in April-Sept. 2006. Additional liquidity of Rs 13,040 crore was absorbed under the MSS till January 25, 2007 and balances under MSS swelled from Rs 29,000 crore on March 31, 2006 to Rs 42,040 crore as of January 25, 2007. If the RBI does not absorb dollars, the rupee tends to appreciate whereas soaking up the greenback frees rupee funds into the system.
Non-food credit expanded by Rs 4,07,735 crore (31.2 per cent) as on January 5, 2007 on top of a rise of Rs 3,11,013 crore (31.2 per cent) a year ago.
Provisional numbers for October 2006 shows a rise of 33.4 per cent in credit to retail and services sectors, forming 49.2 per cent of total non-food bank credit with the share of retail at 25.9 per cent.
Loans to commercial real estate rose by 83.9 per cent with its share in total non-food bank credit being 2.5 per cent.
Money flows to the farm sector (which has a share of 12.1 per cent in total bank credit) grew by 30.8 per cent by October 2006 while the share of priority sector advances dipped from 36.5 per cent to 35.2 per cent.
In yet another attempt to ensure price stability, the Reserve Bank of India on Friday upped the repo rate by 25 basis points from 7.50 per cent to 7.75 per cent and the Cash Reserve Ratio (CRR) by 50 basis points to 6.50 per cent in two phases effective April 14 and take out Rs 15,500 crore from the system.
Also, banks will be earning less on CRR with the RBI snipping interest rate to 0.5 per cent per annum from the present one per cent effective April 14. Banks earn nothing on the minimum CRR of 3 per cent and will now get less on the extra 3.5 per cent.
The move may not hit bank balance sheets for the fiscal ended March 31, 2007, as the twin RBI announcements came after banking hours on Friday.
But the fiscal starting April 1, 2007, could see retail and corporate loans turning costly with deposit rates also going up. Market players were stumped for words as the repo rate (the cost of bank borrowings from RBI) and CRR (the percentage of deposits immobilised by RBI in cash) hikes come when rupee funds are hard to come by.
The RBI, in its elaborate explanation, admits to a sure policy shift to douse inflation and inflationary expectations albeit at the cost of growth. Its press release states: "The stance of monetary policy has progressively shifted from an equal emphasis on price stability along with growth to one of reinforcing price stability with immediate monetary measures and to take recourse to all possible measures promptly in response to evolving circumstances."
Dear money policy
Since mid-2004, the RBI has been working towards a dear money policy, "in recognition of the cumulative and lagged effects of monetary policy."
The wholesale price index (WPI) has been ruling around 6.5 per cent for the third week running up to March 17; prices of primary articles, fuel group and manufactured products showed a year-on-year rise of 12 per cent, one per cent and 6.6 per cent as on March 17 against 3.7 per cent, 8.9 per cent and 1.7 per cent a year ago, respectively. The year-on-year growth in non-food bank credit has been put at 29.5 per cent as on March 16 against 32.7 per cent a year ago.
Deposits have moved up by 24.8 per cent as on March 16 over and above 18 per cent a year ago. Forex reserves have climbed by $18.6 billion from $179.1 billion (end-January 2007) to $197.7 billion as on March 23. The Market Stabilisation Scheme, to mop up rupees arising from purchase of dollars, has mopped up additional liquidity of Rs 23,894 crore between February 1 and March 23.
The RBI takes consolation in the fact that other central banks have been doing the same to hold back prices.
Firming up of crude prices at over $60 per barrel, supply-side discontinuities in farm goods and steep loan growth have together got the RBI to do a repeat of its actions since mid-2004.
In some ways, the RBI has no alternative other than marking up the repo and CRR rates as it has little left in its policy armoury. But the RBI has no say on farm supplies and bulging forex reserves adding to rupee funds.
In buying dollars, the RBI will be enhancing rupee liquidity; if it does not intervene in the forex markets, the rupee appreciates hurting exports. The central bank is in a bind not of its making.
The stock markets as a whole, and bank stocks in particular, could take a hit on Monday following the RBI hike in the cash reserve ratio (CRR) and repo rates.
"The rate hikes will have a negative impact on the markets as it will lead to an increase in prime lending rates of banks. This being the case, the overall sentiment will be weak," said Mr A. Balasubramanian, Chief Investment Officer, Birla Sun Life Mutual Fund.
"It is difficult to say how low the markets will open on Monday morning because the markets are working in sync with global trends and are is able to marginally absorb negative news. But there will definitely be a softening," said Mr Shailendra Jindal, CEO, Mehta Financial Services Ltd.
"The liquidity will not be affected that much because of increased Government spending. There have also been a lot of dollar inflows which will continue to come in," said Mr Balasubramanian.
The RBI has also halved the interest rates on CRR from one percentage point.
"Put together, all these factors will affect the net interest margins in the short run," said Mr R. Rajagopal, Head (Equities), DBS Cholamandalam Asset Management.
Sectors across the board will be hit, but banking and auto stocks are expected to take the hardest blow.
"Banking, real estate and auto sectors will be the most hit because they are driven by interest rates," Mr Jindal.
"Auto and consumer durables stocks will fall. It may also lead to further appreciation of the rupee, which will lead to IT stocks falling as well," said a fund manager.
However, it is felt that sectors like pharmaceuticals, telecom and FMCG will be spared the negative market sentiment.
"There was an indication that further tightening would happen. It is just the timing that has taken everyone by surprise," said Mr Anup Maheshwari, Head (Equities and Corporate Strategy), DSP Merrill Lynch Fund Managers Ltd.
Markets may not like surprises. But that disapproval rarely, if ever, deters central bankers from giving them a jolt every now and then. Act when it is unexpected and sit tight when it is expected, seems to be the unspoken central banking mantra. And Dr Y.V. Reddy has exercised this skill with practised deftness.
The last three hikes in policy rates, coming in rapid succession, in December 2006, February 2007 and the latest one on Friday have happened outside the conventional policy announcements or quarterly reviews. Economists have explained that hiking the Cash Reserve Ration is a comparatively cheaper way to suck out liquidity generated by huge capital inflows (rather than issue more bonds). Forex reserves have gone up by $20 billion in the last three months alone.
Immediate re-pricing of deposit and loan rates by private banks has invariably followed past hikes in these rates. Public sector banks have responded with a little lag. One more round of hikes for home loan borrowers and car loan borrowers seems inevitable now.
Dr Reddy had said at the start of his press conference immediately after the last quarterly review in January 2007, "The surprise this time was that there was no surprise." By now, press persons and the markets must have got used to the fact that the "surprise" is always just around the corner
M.V. Nair, chairman of Union Bank; Devendra Verma, a bond dealer with a private bank; Vinit Kumar, a software engineer and a prospective home buyer; and Atul Shirsat, a retired state government employee—all of them would look back at 2006-07 differently.
Nair would look at the bank’s accounts for the year with a finetooth comb to gauge the impact of the central bank’s monetary tightening measures spread over the year. Verma will not get a hefty bonus this year as he has not made enough money trading bonds. Kumar, on his part, had to postpone his plan for buying a flat as he cannot afford the high home-loan rates.
The only person in this group who is smiling is Shirsat. He is now earning 9.5% on his savings kept with a public sector bank, against the 6% he earned at the beginning of the year.
With Friday’s measures, the Reserve Bank of India (RBI) has raised its short-term rate by one percentage point to 7.75% in four stages this year. It also raised banks’ cash reserve ratio, which determines how much money banks need to keep with RBI, by 1.25 percentage points to 6.5%, taking out about Rs45,000 crore from the banking system.
Commercial banks, on their part, have raised their prime lending rate by an average two percentage points while retail loans, particularly consumer loans, mortgages and auto loans, have risen by between three and four percentage points.
With RBI raising rates at frequent intervals, banks had little choice but to pass on the interest burden. At the same time, to support their loan growth, banks also hiked their deposit rates to attract customers—a move that has benefited the saving community.
A deposit with a term of more than three years, which fetched returns of 6.25% to 7% till a year ago, now gives anything between 9.25% and 10%.
But the rise in loan and deposit rates was much sharper than that in bond yields. Bond prices and yield move in opposite directions. In a rising interest rate scenario, bond prices crash and bond yields rise. With the prices going down, banks are required to make provisions to offset the depreciation in their bond portfolios, affecting profitability.
At present, banks are required to invest a minimum of 25% of their deposits in government securities, or “gilts”. To meet this stipulated liquidity requirement, banks invest in gilts across maturities, ranging from two to 30 years, besides short-term treasury bills.
Over the last few years, banks have invested in shorter maturity paper ranging from three to five years, expecting that their investment portfolio would not depreciate.
The rising interest rate scenario changed all that. While yields on the benchmark 10-year paper swayed between 7.6 % and 8.14% in 2006-07, the rise of bond yields in shorter maturity papers ranging between three and five years has been much sharper— 6.75% to 7.49%.
“This meant that those banks who had thought they had made a smart move by buying short-term paper faced a larger depreciation on their bond portfolio,” said C.E.S. Azariah, chief executive officer, Fixed Income Money Market and Derivatives Association of India.
However, most banks over the past fiscal year moved their SLR investments from the “available for sale” category to the “held to maturity” category. A bank’s bond portfolio consists of three categories of gilts: held to maturity, available for sale and held for trading. Bonds in the held-to-maturity segment do not face depreciation, and hence banks are not reqired to make provisions for their declining prices.
But banks’ investment portfolios are seen to take a hit on account of the depreciation of corporate bonds.
“The negative impact of the valuation on corporate bonds will be much more since the spread between the 10-year benchmark bond and a triple-A rated corporate bond of similar maturity has gone up from 70-80 basis points last year to 150 basis points this year. Most banks have built up considerable portfolios of corporate bonds, which will be hit to that extent,” says Ashish Parthasarthy, head, trading, HDFC Bank. One basis point is one hundredth of a percentage point. Still, banks will make profits as their interest income has risen substantially with the rise in loan growth. However, this story may not continue next financial year, beginning next week, with the central bank likely to further tighten the monetary policy.
The banking industry will see its interest income dip by around Rs 2,000 crore on account of the twin measures to hike cash reserve requirements, coupled with reduction in the interest that RBI will pay on cash reserves.
The total reduction in income on existing reserves due to the reduction in rates will be around Rs 412 crore. On the additional Rs 15,500 crore that banks have to park in on account of CRR, banks stand to lose around Rs 1,500 crore.
These factors in the average cost of deposits for the banking industry and the interest income they stand to lose on account of funds being frozen.
The loss suffered by each bank will be in proportion to its share of deposits. State Bank of India, which has a 20% market share, will suffer a hit of around Rs 40 crore on account of these two measures along.
The impact of these measures on profitability will depend upon the extent to which banks pass on the cost. The immediate impact of the measure would be to increase the cost of funds for banks. Cost of funds would move higher as banks would be left with a higher proportion of non-earning assets on which they would have to pay out interest, but earn nothing.
Impact on NIM’s (net interest margins) could be in the region of 2-3 basis points for banks as a result of the increased CRR amounts and cut in the interest rates. Here again, the impact would be dependant upon the respective banks cost of funds.
Most banks have cost of funds in the region of 4-5 %. However, banks could pass on higher funding costs as further PLR increases in lending rates. This could also lead to a spike in the short-term rates.
Most bankers were expecting short-term rates to stabilise as liquidity was expected to ease on higher government spending, but now expect it to stay at similar levels. The hike in reverse repo rates by 25bps could see bond yields move higher leading to higher provisions towards investment depreciation.
This could have a higher impact on banks reliant on the RBI LAF window to fund their assets. However, for FY07 most banks would have closed their books and higher investment losses could impact during Q1FY08 if bond yields continue to move higher. Most banks had indicated that they were comfortable till around 8% on the 10-year yields
The Reserve Bank of India’s move to tighten liquidity is in keeping with the stance taken by central bankers worldwide. Globally, the process of withdrawal of accommodation in monetary policy is being vigorously pursued.
Since mid-February, 2007, among the leading central banks, the European Central Bank and the Bank of Japan have raised key policy rates by 25 basis points each, while the People’s Bank of China raised one-year lending rates by 27 basis points and the reserve requirements by 50 basis points.
On Thursday, the chairman of the US Federal Reserve Ben S Bernanke sounded a fresh warning on inflation, sparking concerns that interest rates may rise. Other central bankers have also expressed concern over the increase in liquidity.
However, there has been no change in the policy rates of the US Federal Reserve, the Bank of England, the Bank of Canada, the Reserve Bank of Australia and the Reserve Bank of New Zealand, all of which had undertaken prior policy action.
Economists point out that high growth and inflation are global trends and central bankers have to take policy action in conjunction with their peers across other markets.
India’s integration with global markets has made things more difficult for central bankers. For instance, the present hike in interest rates will make Indian markets more attractive for foreign funds.
If fund inflows do perk up, the rupee will head towards the 41 level making Indian exports less competitive. This will force RBI to intervene and buy dollars. By purchasing dollars in the forex market, RBI will end up releasing more rupees thus, adding to the liquidity.
According to RBI, continuation of accelerated external inflows has resulted in accretion of $18.6 billion to the foreign exchange reserves, taking their level from $179.1 billion at the end of January 2007 to $197.7 billion on March 23, 2007.
NO APRIL Fool’s joke, this. Interest rates on most loans, including home loans, could rise by half to one percentage point with the Reserve Bank of India announcing a slew of tightening measures on Friday evening. The measures pass on the burden of managing inflation to borrowers and banks who will pay by way of higher rates and lower profits.
With foreign funds inflow expected to surge and the government about to step up spending at a time when inflation fears continue to haunt, the RBI has chosen to hit the markets with direct, blunt measures that will drain liquidity and make money more costly.
The move aimed at removing the froth from the economy - in the form of speculative investments and consumption demand - may end up moderating economic growth as well. The banking system, already starved of liquidity, will find the going the tough, while stocks could turn edgy when the market opens on Monday.
RBI’s measures include half percentage point hike in cash reserve ratio - the part of deposits that banks have to keep with the RBI as cash - to 6.5%, and a 25-basis point hike in repo rate - the rate at which banks borrow from the RBI - to 7.75%. Also, banks will get far less returns on money parked in CRR with interest rates on CRR halved to 0.5%. At the same time, the central bank has said it will impound another Rs 6,000 crore through an auction under the market stabilisation scheme on April 4.
Even before the system could digest the previous dose of tightening measures, the monetary authority has struck again. It is widely perceived that the RBI is also being influenced by think-tanks within the government.
Just as former Fed chief Alan Greenspan still moves the US market, Chakravarty Rangarajan, chairman of the PM’s economic advisory council and former RBI governor, continues to have an influence on RBI governor YV Reddy’s monetary policy, albeit in a subtle, indirect manner. Mr Rangarajan, a hard core monetarist, is dead against the spiralling growth in money supply - one of the factors that have fuelled the latest bout of inflation.
This is the third in the series of monetary squeeze in four months. Incidentally, the other two hikes were announced outside the monetary policy review on December 8 and February 13. Despite these, year-on-year credit growth was 29% on March 15.
Friday’s CRR hike has dashed all hopes of any immediate easing of rates. Some banks had refrained from raising rates hoping that the RBI was at the end of its tightening phase.
Those banks that have held back rate hikes earlier will now be forced to hike it by at least 100 basis points.
Unlike in the past, this April will turn out to be the cruelest month for the money market. Assuming the end-March tightness to be transient, some banks sanctioned loans but postponed disbursements to April.
Large corporates would be spared to the extent that they are able to borrow from overseas where overall costs have become cheaper with the rupee firming up. Hemant Mishr, MD, global corporate sales, South Asia, StanChart, said: “The difference between an all-hedged foreign currency funding has fallen from 100 basis points to 55 basis points given the upside move on the cost of hedging. Some banks feel it could be RBI’s strategy to let the rupee firm up through higher rates in order to make imports cheaper and bring prices down.”
In a statement, which bankers termed hawkish, the RBI highlighted economic indicators that called for tightening. These included a rise in the index of industrial production to 11% from 8% a year ago. Moreover, inflation had held firm at around 6.5% for three weeks in succession. This was on account of a 12% increase in prices of primary articles and 6.6% rise in cost of manufactured articles. Besides, the year-on-year money supply (M3) growth up to March 16, 2007 was 22% as against 16.9% a year ago.