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| July 31, 2006 | Monday | Rajab 4, 1427 |
Interest rates raised to contain inflation
WITH inflationary worries still haunting the federal government, the Reserve Bank of India (RBI), the country’s central bank, last week once again decided to go in for a hike in a key interest rate.
In line with interest rate hikes carried out by central banks elsewhere in the world over the past few weeks, the RBI pushed ahead with what it described as “a modest pre-emptive action.” The bank raised the benchmark short-term rate by a quarter point to six per cent, a four-year high.
The Repo and Reverse Repo rates (RBI’s short-term lending and borrowing rates) were jacked up by 0.25 per cent to seven per cent and six per cent respectively, though the bank did not fiddle with the cash reserve ratio and the bank rate (which remains at six per cent).
This is the third rate hike this year, and the sixth since October 2004. The previous hike was in the first week of June, after the government raised the price of petroleum products.
RBI Governor Y.V.Reddy notes that the slight increase in rates would keep inflation in check, and ensure that the economy grows at the projected eight per cent. The RBI did not revise its growth projection (of 7.5 to eight per cent) or inflation target (5-5.5 per cent).
In his first quarterly review of the monetary policy for the current fiscal, Reddy expressed concerns over the rising petroleum import bills.
India’s average crude basket price has shot up from $60.1 a barrel during January-March, to $67.3 during April-June, and $71.4 in July.
The Indian rupee has also depreciated 4.7 per cent against the US dollar, while there has been a slowdown in export growth — from 35.4 per cent growth in the first quarter of fiscal 05-06, to 16.9 per cent in the corresponding quarter this financial year. But India’s foreign exchange reserves remain buoyant at $162.7 billion.
But what is most worrying for the RBI is inflation, which has shot up to 7.2 per cent (in June), from a negligible 2.7 per cent a year ago. But inflation, as measured by wholesale price index, was down at 4.68 per cent.
Reddy pointed out that other central banks — including the US Federal Reserve, the European Central Bank, Bank of Japan, the People’s Bank of China, Bank of Canada and the Reserve Bank of Australia — had also gone in for interest rate hikes.
The RBI’s decision was welcomed by the federal government and even the markets. Finance Minister P. Chidambaram said the move was in line with the decision taken by other central banks, and it would ensure healthy and robust growth of the economy. It would help contain inflation, added Chidambaram.
Bank stocks soared on the stock exchanges, and many lenders announced hikes in consumer borrowing rates. LIC Housing finance, and ICICI Bank were the first to announce increases in housing and auto loan rates.
The Bankex, the banking index on the Bombay Stock Exchange, also surged by four per cent a day after the RBI’s announcement. Prominent bank stocks gained up to 15 per cent. But analysts attribute the recovery in bank stocks to the RBI’s move to allow banks to raise hybrid capital abroad, to strengthen their balance-sheet and to prepare for Basel-II norms relating to capital adequacy.
Union Bank chairman M.V. Nair said his bank would increase interest rates on home loans and personal loans this week.
Kalpana Morparia, joint managing director, ICICI Bank, feels that the rate hike would not reduce credit growth. The bank, India’s second largest, expects a 25 per cent credit growth this year.
But Sriram Kalyanaram, head, mortgages and auto loans, Standard Chartered Bank, feels that there could be a slight decline in credit off-take, following the latest interest rate hike.
PUBLIC sector bank employees in India continue to be on the warpath. Last week, over half a million of them observed a day’s strike, protesting against the RBI’s move to allow banks to outsource tasks.
The strike, which crippled banking services across the country, was also to back the unions’ demand for the filling up of about 100,000 vacancies in public sector banks.
Despite reforms in the Indian banking industry, public sector banks have by and large remained insulated from the changes and continue to function in the bad old ways.
Many state-owned banks have been trying to hire top executives from outside the industry, and have raised the salaries for senior professionals, despite stiff opposition from unions. Traditionally, public sector banks have similar staffing and wage patterns, and it is difficult for management to attract talent from outside.
The new private sector banks — including ICICI and HDFC — have been able to get bright young executives from the best of universities, and they have been compensating them handsomely. Private banks also outsource manual and low-skilled services to subsidiaries, and have gone in for automation.
But public sector bank unions, who were initially opposed to automation, have resisted change. The government has, however, not pushed the banks to press ahead with reforms, as many of the staff members are ageing, and following retirement — or acceptance of voluntary retirement schemes — the bank’s are told not to fill up the positions.
The bank unions are controlled by the leftists, who are also opposed to further reforms in the industry. The federal government is keen to dilute its holding in public sector banks to 51 per cent, and wants many of the profitable institutions to raise funds from the public. But the leftists are fiercely opposing these reforms.
Delay in deepening reforms is having a terrible impact on the performance of public banks. State Bank of India (SBI), the country’s largest commercial bank, last week came out with disappointing performance. Its net profit dropped by almost 35 per cent mainly because of higher staff costs.
SBI scrips tumbled on the BSE following the first quarter results. The bank, which has over 9,000 branches, plans to expand abroad. It recently acquired three small banks in Africa and Indonesia, and is keen to expand its international branch network.
State-owned banks are losing market share to the new private banks, and to many international banks that are aggressively expanding their branch network. While public sector banks continue to focus on branch expansion, private banks have been cutting down on costs, and servicing their clients through a wide network of ATMs, and innovative new banking services, including telephone and Internet.
THE slowing down of economic reforms in India is causing concern. The World Bank last week sounded a warning, pointing out that lack of modernisation of infrastructure, rising fiscal deficits, antiquated labour laws and rising interest rates could slow down economic growth.
According to Michael F. Carter, country director, World Bank, the main challenge for India was not raising economic growth from eight to 10 per cent, but to sustain this growth while spreading its benefits widely.
Releasing the bank’s development policy review for the year — titled ‘Inclusive Growth and Service Delivery: Building on India’s Success’ — Carter warned that sustaining overall growth was at risk if efforts to modernise infrastructure — including airports, ports, power plants, and road and rail network — did not keep pace with demand.
The World Bank feels that failure to reform labour laws or speed up financial sector reforms would slowdown overall growth. Carter pointed out the need to accelerate economic reforms to maintain the growth momentum.
The bank is expected to lend over $2 billion to India this year, as against $1.6 billion last year. It would also resume lending to some health projects that were frozen following allegations of corruption.
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