Saturday, June 21, 2014

Opinion: Are interest rates set to fall in India?

While RBI is looking at inflation numbers before reducing the benchmark interest rate, there are many developments which are directed towards reduction in interest rates.


  • Reducing SLR: While RBI left the rates untouched during its last meeting, it reduced SLR (Statutory Liquidity Ratio) by 0.5%, this would mean increase in liquidity at banks or little more money to lend. And RBI had expressed its intentions to slowly do away with SLR that would enable banks to lend more freely than put the money into Gold & Govt. securities like they have to do now.
  • Ending oil subsidy: Diesel prices are being raised 50 paisa a month thereby reducing the subsidy outgo. This is reducing the subsidy slowly and surely. When this subsidy ends, it would mean the necessity to borrow to fund these subsidies by Govt. or OMC will come down. Oil marketing companies were the biggest borrowers and when these subsidies are gone, it would leave more money on the table of the lenders. If LPG, Fertilizer, and Food subsidies also get reduced, call money market would flush with liquidity. Bankers will be able to borrow money from call market at a lower rate than RBI has set.
  • Stronger rupee and softer metal prices to slow down inflation:  While subsidies reduce, deficits narrow down and help to avoid the weakness Rupee has seen in past few years. Fed getting out of QE taking out the air in gold prices. Slowing China has a lesser appetite for metal commodities. Except oil, we are importing deflation. Trends show possibility of trade deficit turning into a small surplus. This is set to make Rupee stronger. It helps our imports costs come down, which reduces fuel bills, so lesser contribution to inflation. Except food items, inflation would moderate in other components of CPI. That would set stage for RBI to act.

There are some probable factors, if and when implemented will help to ease the interest rates.

  •  Tax incentives to boost savings: The new Govt. is looking into revise some of the policies aimed at boosting savings. This would mean availability of long term capital at a lower rate for the industry. Those infrastructure companies who are credit starved can reduce dependency on commercial banks for loans. And banks with surplus capital may want to lend at a lower rates. When the corporate bond market develops further it will have similar effect as both lenders and borrowers will have a platform thereby reducing the load on commercial banks to provide for long term capital needs.
  •  Tax amnesty schemes: While it is not certain if an amnesty scheme will be rolled out to convert black money into white or bring back stashed cash from abroad, but if implemented it will increase liquidity in the system greatly. And the competition to lend will intensify and offer relief to borrowers.









Risks to assumptions:


Like every assumption has its risks, this too comes with its bag of risks and adverse conditions.


  • If food prices go up due to insufficient rains and thus increase inflation, it may tie RBI’s hands or even make it raise the rates further.
  • Govt. adopting populist schemes and giving fiscal discipline a miss, this risk looks remote in the given scenario but events like drought, war may force Govt. to consider that.
  • If interest rates in US and other developed markets rise significantly and trigger a reversal of FII inflows beyond a point which cannot be supported from the forex reserves built by RBI.

Conclusion:

All in all, given the data and trends, interest rates are more likely drop than stay flat or go up further. Individuals will see relief in their EMI burden and Corporate see expanding earnings. But which sectors will benefit most? Will it be infra and real estate?