Hardening of interest rates not ruled out

By Oommen A. Ninan

MUMBAI, MAY 1. Eventhough the Reserve Bank of India is striving for a downward trend in interest rates, the ground realities are pointing to a northward journey of rates in this fiscal. The central bank's concern with inflation points to the possibility of a tightening monetary policy during the year.

``Interest rates have bottomed out and are unlikely to go further down, but there is every possibility of their firming up,'' said Mr. N. J. Jhaveri, Director, Kotak Mahindra Capital Company. The Government's borrowing programme is very large and quite worrisome and this leaves very little latitude if private sector credit demand picks up significantly. Interest rates are now low mainly because there is little investment demand from the private sector. As banks have invested more than Statutory Liquidity Ratio (SLR) requirements in government securities, when the private sector demand picks up interest rates cannot remain at these levels. ``However,'' said Mr. Jhaveri, ``I don't see any sharp rise in interest rates because of healthy foreign capital inflows.''

In 2000-2001, the gross and net borrowings of the Government are projected at Rs. 117,704 crores and Rs. 76,383 crores respectively. As per the revised estimates in the Union Budget, the Centre's fiscal deficit - excluding small savings - for 1999- 2000 was higher at 5.6 per cent of GDP as against the budgeted figure of 4 per cent. As a result, gross market borrowings exceeded the budgeted level by Rs. 15,616 crores. In addition, State governments' gross market borrowings amounted to Rs. 13,706 crores as against Rs. 12,114 crores in the previous year.

The Reserve Bank of India has stated, ``The large borrowing programmes of Government year after year have also put pressure on the absorptive capacity of the market.'' The banking system now holds government securities of around 34.3 per cent of its net demand and time liabilities as against a minimum statutory requirement of 25 per cent. In terms of volume, the holdings above the SLR amounted to about Rs. 85,000 crores, which is higher than last year's net borrowings.

While announcing the Monetary and Credit Policy for the year 2000-2001, the RBI Governor, Dr. Bimal Jalan, has cautioned against inflation. If inflation goes beyond a certain point he has indicated that the monetary policy will be tightened. ``The repeated references to the possibility of rising inflation reflect RBI's concern on this front and if inflationary pressures arise, RBI is likely to resort to a tightening bias, and this raises the possibility of rising interest rates,'' said Mr. M.R. Madhavan of ICICI Securities and Finance.

Dr. Jalan has said the monetary policy aims ``to provide sufficient credit for growth while ensuring that there is no emergence of inflationary pressures on this account.'' Mr. Madhavan pointed out that though there is no direct mention of a tightening bias, various references to inflation control suggest this. Again, while the monetary target of 15.5 per cent growth in M3 is set assuming 6.5 to 7 per cent GDP growth and 4.5 per cent inflation - average of last two years, the RBI warns, ``it cannot be overemphasised that the above outlook can change dramatically within a short period of time...... On the inflation front, there is need for continuous vigilance and caution.

The Reserve Bank will continue to monitor domestic monetary and external developments, and tighten monetary policy through the use of instruments at its disposal, when necessary and unavoidable''.

Stressing the point that interest rates cannot go down further Mr. Jhaveri said that the only way interest rates can go down significantly now are by reduction in transaction costs and provisioning, but these would not happen in a short span.

The RBI also pointed out that one factor which is affecting the interest rate structure in India is the high level of non- interest operating expenses of public sector banks. These work out to 2.5 to 3 per cent of total assets. While much greater flexibility in the structure of interest rates in tune with changes in the inflationary environment is desirable, the RBI has stated, ``There is no ``quick fix'' solution to engineer a sharp fall in nominal deposit and lending rates of banks.'' Vigorous action has to be taken by banks to reduce their transaction costs and volume of non-performing assets and improve risk management.

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