Booster Dose #2: RBI cuts rates, eases credit availability, warns of painful adjustment

On Saturday, the RBI presented its part of the stimulus package, a combination of interest rate cuts, credit flow improvement, relief to exporters and rescuing banks from showing red ink on their books. Since mid-September, the RBI claims to have made available primary liquidity of Rs 300,000 crore. While the October crisis has blown over, when money evaporated from the system, it still does not appear as if there is money sloshing around.

In general the real interest rates, charged on all loans and paid by banks to depositors has not come down significantly. There are small pockets: home loans of less than Rs 20 lakh have become cheaper and deposits of certain maturities by certain banks have become cheaper. But overall money has not become cheap; banks unwillingness to sharply drop deposit rates is an indication that they fear that supply will drop away, leading to a crisis. Loans are not becoming cheaper, because deposit rates are still high, and banks are hanging on to margins because they will need it to cushion rising non-performing assets.

So, if interest rates have to really fall, then what is needed is a steady stream of cash flowing into the system. Will the current RBI measures lead to this? Not directly, but it has to do its bit and wait for the environment to improve too

1. The repo rate has been lowered from 7.5% to 6.5%, this is the rate at which banks borrow from the RBI and the reverse repo rate to 5% from 6%. This is the rate at which banks park funds with the RBI. This is a signaling tool for interest rates but right now, the market is not really following the signals, at least in the recent past. As said earlier, market conditions are dictating interest rates and the regulator’s voice may be sane but is not being heard. Banks have been openly saying they will lower interest rates when the time is right.

2. SIDBI will be given refinance worth Rs 7,000 crore to lend to small institutions (SMEs) at the repo rate for a 90-day tenure that can be rolled over. The facility will be available till March 2010. This is a good idea if implemented well, for it could ease the working capital crunch faced by these firms. But Rs 7,000 crore is small change compared to what would actually be needed.

3. There will be a similar refinance facility for Rs 4,000 crore for housing finance companies, to be administered by RBI. Again, the amount is inadequate.

4. Companies with FCCBs can buy back these instruments using foreign currency resources if there is a minimum 15% discount on the book value of the FCCB and can also use rupee denominated funds, if there is a minimum 25% discount on book value. If rupee funds are being used, maximum buyback can be $50mn and internal accruals have to be used, i.e. they cannot borrow and buyback. Buyback allows companies to retire forex liabilities early and the safeguards ensure that all companies do not rush to buyback, creating more problems.

5. Banks can give loans to housing finance companies for housing loans of upto Rs 20 lakh and treat that as priority sector. The limit has been raised. HFCs will get funds but are there good and willing borrowers? And at Rs 23 lakh (Rs 20 lakh plus Rs 3 lakh margin money), where does one find houses in most metro cities?

6. This is a big one. Banks can now roll over commercial real estate loans and classify them as restructured standard accounts in the standard category. Earlier, this category along with capital market exposures and personal loans did not get this benefit. Devoid of jargon, what this seems to indicate is, yes, real estate players have thrown up their hands, banks will have to provide for these bad assets, but that will look ugly and create panic, so we are allowing them to dress over these loans. This is valid upto June 2009.

7. And a bigger one. All loan categories which currently have this benefit of rolling over loans, showing them in the standard category, can do this restructuring the second time too and get this exceptional treatment. This is a clear sign that banks are under a lot of pressure. No wonder they are in no hurry to take on fresh liabilities.

If the next few weeks see a sustained all round drop in interest rates, across banks and categories, we can say the RBI has played its cards right. But if the current trend continues, of symbolic and selective rate cuts, we will know that there is a lot of time for that painful adjustment to happen.

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