Tight Money Supply Fears Douse Rate Cut Hopes

Market responses seem to challenge the optimism on interest rates voiced in recent days by finance minister P Chidambaram, Reserve Bank governor C Rangarajan, Indian Banks Association chairman Rashid Jilani and ICICI chairman N Vaghul. Interest rates will remain unchanged in the short term, but will start rising after the busy season sets in, State Bank of India chairman P G Kakodkar told Business Standard.

Three events in recent weeks indicate that the market is becoming immune to official measures. They are:

for the first time, RBI's intervention has failed to enthuse banks to buy government paper;

reduction of PLR by SBI did not have a ripple effect on interest rates in the banking sector; and

 

the recent cuts in CRR were largely absorbed by the money market instead of easing interest rates.

There may be some respite because of government initiatives. But money supply is bound to tighten as demand is set to go up as the pending projects fructify. On the other hand, there is a drop in savings, says ICRA managing director P K Chaudhary.

The main reasons being cited for a tight money situation after Diwali are:

bunching of overseas repayments amounting to $6.5 billion;

a strong likelihood of the government's market borrowings exceeding the target of Rs 33,000 crore; and

FIs have disbursed over Rs 10,000 crore as long-term loans out of the funds raised through recent bond issues. Corporates which have accessed these loans will start seeking working capital funds from banks.

Recent initiatives to improve money supply and cut interest rates include permission to FIIs to deploy 100 per cent of their funds in debt instruments, tax exemption on investments in infrastructure, reduction of PLR by the SBI and the continued effort by the RBI to lower yield rates on government paper till it was forced to raise it in the last issue.

An improvement in the flow of foreign funds or even a slight increase in the rate of domestic savings will, however, have a sobering effect on interest rates, banking circles said. A lot will depend on the success of SBI's GDR issue which can improve the climate for subsequent GDR issues. Some bankers warn against reading too much into the devolvement of the 6-year paper. This has happened because the government entered the market at the wrong time, a senior banker said. Vaghul suggests a different reason for the low credit offtake which the SBI has complained about. There is a theory that a lot of finance is being choked in the banking system. I am getting complains from good corporates that banks are not forthcoming with short-term funds,he said.

And yet bankers are not convinced that the liquidity situation is easy enough and feel that a tightening is round the corner. The demand pressure on banks is bound to increase in the next two months. The call money rates have already begun to increase and now hover around 10-11 per cent, a senior bank official said.

Another indication suggesting an upward push in interest rates is the secondary market for gilts where 91-day treasury bills are selling for higher yields than what is being offered by the government on fresh paper. What is more, the so-called easy liquidity situation has had very little effect on interest rates on inter-corporate deposits and leasing finance.