The Hindu Business Line : Interest rates bite

From the rather pessimistic sales outlook of the automobile sector for the festive season just round the corner it becomes evident that the tight money policy and hardening interest rates have begun to impact consumer spending. Industry spokesmen are not sanguine that this year’s growth will match last year’s, a gloomy scenario that is shared by other sectors too, such as paper products. Clearly, the Reserve Bank of India’s tightening of monetary accommod ation is beginning to show results at a most inconvenient time for the government. With the possibility of the lagged effect spreading to other sectors and falling demand slowing overall growth now more palpable than ever before, the policymaker has to make choices that are seemingly contradictory. On the one hand, a tighter interest rate regime may dampen prices, which may not be such an undesirable result. On the other, such a regime may choke existing demand, and trim the growth story.

Last Friday, the Finance Minister, Mr P. Chidambaram, opted to address the second problem when he urged bank chiefs to cut interest rates so as to stimulate demand, at least in the auto and paper products sectors. Behind this specific plea lies a broader message about reduction of interest rates, in general, at least for productive sectors. Data on credit growth this year show that coupled with high deposit growth the deceleration of credit growth has led to a marked fall in the incremental credit-deposit ratio to 70 per cent this July from 96 per cent 12 months ago and 110 per cent in March 2006. Interestingly, infrastructure absorbed nearly 25 per cent of incremental credit with personal loans accounting for 24 per cent, of which housing alone absorbed 11 per cent while incremental credit to the commercial real estate sector, according to the RBI, remained “high”. Thus within the overall decline in credit growth, infrastructure has acquired importance but given its gestation the impact on demand may not be as immediate as growth in consumer credit. In any case, higher interest rates seem not to have affected housing or real estate, the sectors that the RBI wanted banks to curtail lending to. Instead, the high loan rates are affecting those sectors such as automobiles with high backward linkages and employment potential.

The plea that high deposits rates do not give banks much room to reduce loan rates without margins being affected is not convincing. With de-regulated rates, most banks, even the nationalised ones, have the flexibility that permits them to keep a watchful eye on margins. What they would lose in value by reducing loan rates can be made good through higher business volume. Most banks offer seasonal discounts. But reducing interest rates would send more positive signals about the prospects for a demand revival than festive offers can.

Related Stories:
Chidambaram for cut in rates to spur demand
Rate hikes slowed down auto industry: Tata Motors
Divergent views on interest rate impact on auto sales

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