High rates could cool loan growth, ease inflation worries

The Reserve Bank of India may get some respite in its battle against inflation in the current financial year with bankers forecasting a lower credit growth on rising interest rates.

Credit growth is the biggest and most potent contributor to demand-side inflation and therefore banks -- the largest channel of loan disbursements -- are seen as the most effective tool to manage inflation.

Most banks expect credit growth of 18-22% in FY12 percent compared with 21.4% a year ago on higher rates and expectations of further hikes this year.

India's central bank is seen raising rates by a quarter point on May 3 and analysts now expect it to raise rates by a total of 75 basis points for the rest of 2011, or 25 bps more than they expected in mid-March, a Reuters poll found.

"Another 25 basis points may not be very much, but if it is going to be 1% in the next two quarters, then it will be a problem," said S Raman, chairman and managing director of Canara Bank.

"Banks have not passed on the last time's interest rate increase. If something now happens it will have to be passed on, and if the RBI goes on aggressively increasing rate of interest, it is going to be a bit more difficult," he said.

The Reserve Bank of India has so far raised its key lending rate by a total of 200 basis points since mid-March last year to tame inflation.

The wholesale price index , India's main inflation gauge, rose 8.98% in March from a year earlier, higher than the RBI's upwardly revised projection of 8%.

Analysts said high lending rates at banks could slow down demand for credit from corporates and also in retail sectors.

"Even at current interest rate levels, growth has been impacted. Imagine what will happen if we raise it further. Demand will suffer and growth will certainly slow," said a senior executive at a large private bank who did not wish to be identified.

Economists expect liquidity in the banking system to remain tight following the successive rate increases, further pressuring credit growth.

"The basic assumption that we are working on is a negative 1% of NDTL (Net Demand and Time Liabilities)," Indranil Pan, chief economist, Kotak Mahindra Bank, said.

Incremental credit-deposit ratio

Indian banks' incremental credit-deposit (C-D) ratio, a gauge of banks' dependence on deposits to fuel credit growth, had shot up to nearly 100 percent in FY11 compared to a usual 70-75%. It was 71% in FY10.

The rising incremental C-D ratio had prompted a concerned RBI in January to warn banks to moderate credit growth to its projection of 20% for 2010/11.

The RBI would keep a close eye on the incremental C-D ratio, as a surging ratio could add to inflationary pressures.

However, bankers said incremental C-D ratio in FY12 will not show abnormal growth.

"Interest rates have increased and deposit accretion is there. It is not going to be a major issue, at least in the first half of this year," said Canara Bank's Raman. "And it is the lean season right now."

Credit demand from banks to fund third-generation spectrum acquisitions had pushed up the incremental C-D ratio last fiscal but that will not be there this year, said M Narendra, chairman and managing director, Indian Overseas Bank.

Still, Raman expects incremental C-D ratio at around 85% in the first quarter, about 90% for the first half, and as high as 90-95% for the fiscal.