Interest rates unlikely to come down in a hurry

Looks like interest rates will stay up a little longer.

This, despite the fact that headline inflation, or inflation measured by the wholesale price index (WPI), for July, came in at 6.87% on Tuesday, versus 7.25% logged in June.

Most market watchers believe the decline was a mere blip and that the Reserve Bank of India (RBI) will act only when there is a sustained fall in inflation.

“The data were not as benign as first blush would suggest. The lagged impact on June’s sharp fall in oil prices, which has since partially reversed, was the key driver,” Richard Iley, an economist with BNP Paribas, said in his report on Tuesday.

Energy prices account for a 14.9% share of the WPI basket, so any fluctuation in the segment has a significant bearing on the overall index.

According to Iley, energy inflation declined to 5.92% year on year vis-a-vis 10.26% in June. More specifically, petrol prices slipped almost 4% on the month and diesel prices enjoyed helpful base effects. Prices in July and early August have, however, once again picked up, “partially reversing June’s fall, suggesting that the disinflationary windfall from lower oil prices is likely over”.

Deutsche Bank chief economist Taimur Baig and economist Kaushik Das also noted that the easing was mainly on account of a drop in fuel prices, led by sharp disinflation across items such as light diesel oil, furnace oil, naphtha, ATF and petrol.

Besides, there has been no letup in core inflation, which, in fact rose to 5.4% in July, compared with 4.9% in June.

“Core factory gate inflation, despite a stagnant industrial sector, showed a worrying pick-up that will not escape the RBI,” said Iley.

Indranil Sengupta, India economist, DSP Merrill Lynch, however, sees a cut of at least 50-75 basis points (bps) in the repo rate, or the rate at which banks borrow from the RBI, before the end of this fiscal.

“Unfolding events support our call that an easing of bank liquidity will soften lending rates by 100 bps to support recovery in early 2013. In our view, lending rate cuts hold the key to recovery. In fact, India is the only BRIC in which lending rates have hit their 2008 peak, although inflation is a relatively moderate 1.3 times of growth,” he wrote in a report on Monday.

Sengupta also expects the RBI to reduce the cash reserve ratio, or the proportion of deposits banks are require to hold in cash to meet any future exigency, by 50 bps in its October 30 monetary policy review and pump in as much as Rs80,000 crore into the banking system through open market operations by March. This will help improve the liquidity situation considerably, prompting banks to reduce deposit rates.

Bankers too, do not expect any reduction on the base rate front immediately as inflationary pressures persist and deposit rates continue to be sticky.

“The only way you will see any reduction in lending rates by banks is if the deposit rates come down. With inflation at such high levels, banks won’t get any deposits if they reduce rates,” said R K Bansal, executive director, IDBI Bank.

Banks have largely held on to their base rates, as the RBI refused to reduce the repo rate after a 50 bps reduction in April.

“As per our last assets and liabilities committee (Alco) meeting, we have decided to keep our lending rates unchanged. However, in our next Alco meeting (to be held at the end of this week), we will discuss if we need to take a downward view on lending rates in the long term,” said Paul Abraham, chief operating officer, IndusInd Bank.

However, banks will continue to reduce lending rates on specific sectors where credit quality can be maintained with good growth, said a senior official at a public sector bank.

Recently, the State Bank of India, India’s largest lender, reduced lending rates in the home loan and auto loan segments by up to 60 bps.

On Monday, Indian Overseas Bank reduced home and auto loan rates by 75 bps and 50 bps, respectively, according to M Narendra, chairman and managing director.

On the corporate lending side, though, things are not looking as bright.

“There is a distinct slowdown in the capital expenditure cycle as greenfield projects are getting delayed,” said Abraham.

According to a recent report by Crisil, the capital goods sector’s credit quality has come under strain, with working capital requirements surging to a five-year high. The pressure is primarily due to the deferment of large capital investment plans since FY12 by several end users.

“The resultant build-up in inventory and delay in release of payments by customers has led to a tight liquidity,” the report said.