The Hindu Business Line : Case for hike in lending rates

Mumbai, June 20 Talks of another rate hike by the Reserve Bank of India have become louder, as the inflation for the week ended June 7, 2008 touched 11.05 per cent. A double-digit inflation of around 10 per cent was anticipated, considering the direct impact of the fuel hike. But the indirect impact of rise in prices of other commodities was not expected to be seen so soon, analysts said.

According to Ms Sonal Varma, India Economist, Lehman Brothers, the reason for the high inflation is the fuel price hike and also the rise in manufactured products, which has a weight of 63.8 per cent in the inflation index.

Apart from the direct impact of hike in petrol, diesel and LPG there has also been the impact of non-administered fuel prices such as ATF and naphtha.

Electricity prices also went up marginally last week. “The prices of food products, chemicals, iron and steel, and transport equipment went up due to rising input costs and this also added to the higher than expected inflation figures,” she said.

Quick impact

Terming the inflation figures as striking, Mr Siddhartha Sanyal, Economist, Edelweiss Capital, said the reason that indirect impact of inflation was seen so quickly was perhaps because manufacturers could not absorb the impact of fuel price hike. “Typically the indirect impact of fuel price hike can be spread from few weeks to few months. But the prices of food grains, oil seed and fibre saw a hike over the last two weeks, which pushed up inflation,” he said.

With all indicators pointing towards higher interest rates, there is a case for banks to hike lending rates, in order to maintain their margins, said bank officials.

Mr Sanyal said, “Given the current liquidity situation, banks may find it difficult to cut deposit rates. So, there is case for hiking lending rates, to maintain margins.”

No proactive steps

However, Mr V. Vaidyanathan, Executive Director, ICICI Bank, ruled out proactive measures from the banking industry, in terms of hiking lending rates.

“We will have to wait for policy measures. This inflation is above our expectations. But the various measures by the government and RBI work with a lag and we have to live through the period,” he said.

Further monetary tightening by RBI cannot be ruled out, Ms Varma said. “We expect another 25 basis points hike in repo and 100 basis points hike in the Cash Reserve Ratio.

The reason that RBI may hike both the rates is that you need CRR hike and tight liquidity to ensure that repo is the effective rate, but timing of the CRR hike will be conditioned on liquidity,” she said. A hike in repo rate is a clear signal to banks to hike lending rates, she added.

According to Mr R.V.S. Sridhar, Vice-President (Treasury) of Axis Bank, the RBI will be forced to act before the policy announcement in July. “The reason the RBI will raise both repo and CRR is that if you raise repo it will tighten the rate of lending, because the rate at which banks raise funds will also go up. If the RBI hikes only CRR, then if liquidity comes into the market, it will be undone,” he said.