Tuesday, September 1, 2009

A BRIEF HISTORY OF INTEREST RATES -- 2002-2009


The Indian economy is probably on the last leg of the contraction curve i.e if we go by the latest government data. The New Delhi-based Central Statistical Organisation or CSO says the GDP grew 6.1 percent y-o-y and by 0.3 percent sequentially.

With the growth curve moving into the expansion phase...its a matter of time before the excess M3 supply in the system stokes inflation. Which, technically means going forward the RBI/government will be training its guns to tame inflation and hope that growth will ride on its own...or in other words RBI will look upto Bernanke to fuel expansion.

Historically, however, thats been the story...economic growth in India was more a fallout of a global story and been hardly driven or planned by the government/RBI. But, then thats another story for another day.

So, are the days of lower interest rates on consumer loans over? My guess is that we have seen the last of rate cuts, which means interest rates from here on will either be steady or on the upward curve. Interest rates will hold steady for the next six months -- any tinkering in rates might stifle growth -- and then a 50 basis point hike.

Having said that..lets review our interest rate curve over the last seven years (Jan 2002-Sept 2009), which withstood the cycle of boom-to-near-bust.











Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2009 4.00 4.00 3.50 3.25 3.25 3.25 3.25 3.25

2008 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 5.00

2007 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00 6.00

2006 5.25 5.50 5.50 5.50 5.50 5.50 5.75 6.00 6.00 6.00 6.00 6.00

2005 4.75 4.75 4.75 4.75 5.00 5.00 5.00 5.00 5.00 5.00 5.25 5.25

2004 4.50 4.50 4.50 4.50 4.50 4.50 4.50 4.50 4.50 4.50 4.75 4.75

2003 5.50 5.50 5.00 5.00 5.00 5.00 5.00 4.50 4.50 4.50 4.50 4.50

2002 6.50 6.50 6.00 6.00 6.00 5.75 5.75 5.75 5.75 5.50 5.50 5.50

Between Oct 2008- July 2009 interest rates on advances has been cut between 125-275 basis points by public sector banks, followed by 100-125 basis points by private banks and 125 basis points by five major foreign banks.

While, the reduction in term deposit rates between October 2008 and July 20, 2009 has been in the range of 125-325 basis points by public sector banks, 100-375 basis points by private sector banks and 125-300 basis points by five major foreign banks.

Now let’s compare the reverse repo rate between Oct 2008-July 2009 period with the 19-month period starting Aug 2003. While, this rate are now at a historical low the same doesn’t hold true for bank interest rates. Consumer loans are now priced upwards of 9 percent (in some cases 8 percent) while the BPLR is between 11.75-12.25 percent. That’s almost 200 basis point upside of 2003-2005 rates when consumer loans were available at 7 percent and BPLR were at 10 percent.

Given these conditions no wonder we have the RBI guv claiming that banks are in a position to cut rates further. While, the banks in a bid to safeguard their Net interest margins doesn’t subscribe to that view. So, is the RBI just a regulatory body who can advise/set-up a roadmap but without any power to enforce??

I guess the devil lies in the government borrowing programs...

To instill life into the dying economy..the government had injected about $5.6 trillion rupees ($115 billion) in the economy. Add to this a 21 percent pay rise for 5 million government employees and a farm loan waiver of $17 billion as part of election bonanza. To fund all these the government plans to raise a record 2.15 trillion rupees -- a hike of 50 percent than initially estimated -- through issue of bonds.

So, the yield on the key 7-year government bond have hardened and are now at a nine-month high of 7.43 percent as against a 4.80 percent rate in 2003/04. And, Investors who subscribe to these government bonds -- primarily scheduled banks, FIs -- are already demanding a premium on the coupon rate to subscribe to the 10-year bonds over one-year notes.

So, with a bond yield of nearly 8 percent on the back of widening fiscal deficit..no wonder the consumer loan rates or lending rates are stuck at 9 percent. And, herein lies the devil!!

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