Story on Credit Policy

Reddy strikes the right notes

Sandeep Singh

Posted online: Monday , April 30, 2007 at 1357 IST
Updated: Wednesday, June 29, 2005 at 1257 hours IST -->

For a while now, Reserve Bank of India governor Y.V. Reddy’s policy notes haven’t exactly been music to your ears, especially if you were servicing a fat home loan whose interest rate moved up and up with Reddy’s inflation baton, or if you were interested in taking a loan. After several successive policy announcements that signalled higher rates, Reddy has held the rate line this time, which should soothe nervous borrowers.

Interest ratesReddy has left key rates unchanged, which is also likely to be the response of most banks to most interest rates — both, deposit and lending. However, bankers say it would be presumptuous to see this as a sign that the 18-month long trend of rising interest rates is reversing.
The central bank, they feel, couldn’t afford to raise rates so soon. Says Sudhir Joshi, treasurer, HDFC Bank: “The last increase in the case reserve ratio came into effect as recently as on April 28. So, another hike in such a short span might have been hasty.” The central bank, bankers say, is in wait-and-watch mode. “By its own admittance, the RBI’s check-inflation stance has not changed. If the economy is still awash with funds, another interest rate hike might happen.”
Home loansOne rate that could fall is that of small-ticket home loans. With the objective of keeping houses affordable for small borrowers and increasing loan demand in this segment, the RBI reduced the risk weight on home loans of less than Rs 20 lakh from 75 per cent to 50 per cent.
For every kind of loan it gives out, a bank needs to back it with some capital. How much depends on the credit-worthiness of the loan. The riskier a loan, the more capital it has to put aside. A reduction in risk weight for home loans below Rs 20 lakh means banks will have to provide less capital than before for such loans, which gives them an incentive to give out more such loans.
In order to incentivise borrowers from taking such loans, they should reduce rates, but they might not or do so only marginally. Says Sangeet Shukla, head of personal banking, State Bank of India: “When rates were rising, we did not raise our rates in step. So, we will have to see if we can drop rates now. The reduction, if any, will be 25-40 basis points.”
At a broader level, the RBI’s policy tack signals a status quo on home loan rates, which had been rising at an alarming pace — in just 18 months, the rack rate for a 20-year floating-rate loan had increased from 7.5 per cent to 12 per cent. Says, S.C. Gupta, chairman and managing director, Punjab National Bank: “A further rate hike is ruled out for now.” If inflation gets reined in and demand for funds drops, home loan rates could even fall.
NRI depositsAnother rate that could fall is that for NRI (non-resident Indian) deposits. The RBI sets limits on the interest rates banks can give on various kinds of NRI deposits. With the probable intention of stemming inflow of dollars into India, the RBI has reduced the ceiling on FCNR (B) and NRE deposits — deposits made by NRIs in a foreign currency and rupees, respectively — by 0.5 percentage point.
Mutual fundsIndian mutual funds were first allowed to invest in overseas securities in mid-2003, within an overall limit of $1 billion for the entire industry and $50 million for each fund house. These limits have been increasing. Before the credit policy, they stood at $3 billion for the industry and $150 million for a fund house. Reddy has now bumped up the overall limit to $4 billion.
It’s timely because the number of schemes investing abroad is gradually increasing. Principal Global Opportunities Fund and Templeton India Equity Income Fund are up and running. Fidelity International Opportunities Fund has its new fund offer (NFO) on. And some others like Kotak and Sundaram are queuing up.
Fund houses that are close to using up their assigned quota are waiting for the fund house limit to be raised before launching more schemes in this space. Principal, for instance, is currently using $106 million of its assigned $150 million. Says Rajan Krishnan, business head, Principal PNB Asset Management Company: “Previously, when the industry cap was raised by $1 billion, the fund house cap was raised by $50 million. By the same argument, we expect the fund house limit to increase to $200 million.” Either way, expect more choices in overseas funds.
Overseas investmentsBy yourself also, you can invest more abroad, with the RBI doubling the annual remittance limit for individuals to $100,000 (in today’s exchange rate, about Rs 41 lakh). It still won’t buy you a share of Warren Buffet’s investment company Berkshire Hathaway, which was last trading at $1,09,400. In fact, unless you are well-connected abroad, this increase means nothing in the investment space.
The RBI has been bumping up this remittance limit, Sebi has been slow to frame rules for banks and mutual funds to sell overseas investment products. Says Krishnamurthy Vijayan, chief executive officer, JPMorgan Asset Management India: “Banks and mutual funds can’t do it, and intermediaries don’t have the expertise. The only way you can invest abroad is if you have a relative or friend who will facilitate this transaction for you.” Fund houses are waiting for Sebi to draw rules. Says Ashu Suyash, managing director and country head, Fidelity Fund Management: “We are waiting for guidelines from Sebi so that we can help investors invest abroad.”
StocksThe signal the RBI seems to be sending out is that it wants to keep growth high, inflation permitting. For 2007-08, the central bank has projected GDP growth of 8.5 per cent, which suggests buoyant demand. If the economy grows at that pace, a large part of the corporate sector should maintain the growth momentum. But if inflation doesn’t pipe down, Reddy’s actions might not be music to your ears.

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