Burdened by increasing curbs

Even as the last year saw the Reserve Bank going all out in its war against liquidity, banks see hope in a possible rate cut this year

MUMBAI: Before the budget day in 2007, the banking sector was reeling under an onslaught of interest rate hikes by the Reserve Bank of India (RBI).

As it turned out, the RBI hiked the cash reserve ratio (or the proportion of deposits banks need to place with the central bank) three times in 2007- 08, besides hiking the ceiling for market stabilisation scheme (MSS) auctions five times as it launched an all-out war against potentially inflationary liquidity.

The result was that lending rates were on the upswing in 2007-08 and credit growth crawled to a mere 22% after having registering a growth of over 30% in the previous year.

But this year’s budget brings a lot of hope for bankers. Interest rate hikes are almost past them, thanks to a global lowering in rates in the aftermath of the US subprime crisis (In the last two months, several of the top central banks have reduced interest rates and pumped in cash to bail out banks). With the lower credit growth attracting the attention of both the RBI and finance minister, bankers are expecting business (read loan growth) to pick up in 2008-09.

Gunit Chadha, managing director and chief executive officer, Deutsche Bank India, says if the budget is “pro-growth, pro-capex and pro consumption”, the primary needs of the banking sector will be taken care of.

“Banks are a surrogate of the corporate sector and if the budget fundamentally drives the growth of India Inc together with strong risk management from the RBI, banks will benefit. Of course other measures like incentives for banks in infrastructure financing and developing a corporate debt market will help, but I think it is only a second degree,” Chadha said.

India Inc has been facing a sort of a mini crisis in financing for the last few months. While overseas lending rates had risen and procedures tightened in the wake of the liquidity crisis following the subprime fiasco, Indian banks have also not been able to offer them better deals due to the tight leash on domestic liquidity by the RBI.
Bankers are hoping that some benefits for corporate India would tickle down to the banking sector in 2008-09.

But that’s the corporate side of things. Bankers also have a long pending wish list related to the retail sector. The difference in the tenure between products of the banking and the mutual funds industry to be eligible for tax-concessions has been a bone of contention for bankers for some time.

Currently, money in a special tax saving fixed deposit with banks has to be locked in for five years to be eligible for tax relief under Section 80C of the Income Tax Act. However, if invested in a tax-saving mutual fund, the lock-in period is only three years.

Bankers demand that the lock-in for tax-saving fixed deposits be brought on par with that for mutual funds.

“My wish list for the budget would be the removal of the negative tax arbitrage between mutual funds and fixed deposits,” said IDBI chairman and managing director, Yogesh Agarwal, at the sidelines of a bank function recently.

The recent record successes in the stock market have also attracted retail investors towards mutual funds. On average, the return on a equity linked saving scheme (these are mutual fund schemes that enjoy tax benefits) has been around 26% in the last one year, compared with 8-9% for a tax-saving fixed deposit.

Moreover, the returns for MFs are also not taxed after the lock-in period is over. Currently, returns on  5-year bank deposits are taxed between 10% and 30% depending on the income tax bracket the investor falls in.

Even mutual fund schemes like fixed maturity plans (FMPs) are taxed only at 20% with indexation or 10% without it (whichever is lower) if the investor holds on to the scheme for more than a year. So, high net-worth individuals prefer FMPs over bank deposits.

Insurance is another lucrative option for investors seeking to save tax. These policies have a lock-in for 3-years and offer a mix of returns and an insurance cover.