Record Lending Confounds Subbarao as Banks Lag Behind Policy: India Credit

Reserve Bank of India’s five interest-rate increases this year are failing to stem a surge in credit, showing the challenges Governor Duvvuri Subbarao faces in keeping inflation in check as the economy expands.

Loans to companies including Essar Steel Ltd. and Videocon Industries Ltd. climbed 36 percent to 2.1 trillion rupees ($45 billion) this year, the most since Bloomberg started compiling the data in 2002. State Bank of India and ICICI Bank Ltd., the nation’s two biggest, have raised their lending rates by 50 basis points since March, less than half the 1.25 percentage- point increase in the central bank’s benchmark repurchase rate.

The central bank said in a statement yesterday that inflation “may remain high for some months” as policy makers lifted borrowing costs. Neighboring China, facing the same dilemma as India, is using tighter capital rules to slow lending rather than raise interest rates.

“The real concern is that the banks haven’t passed on much of the policy rate hikes and that has fueled asset-price gains,” said Robert Prior-Wandesforde, an economist at Credit Suisse Group AG in Singapore. “The risk is if interest rates remain loose, signs of overheating will intensify.”

Not Enough

Subbarao boosted the repurchase rate to 6 percent from 5.75 percent, and raised the reverse-repurchase rate to 5 percent from 4.5 percent, the RBI said in a statement in Mumbai yesterday. He has increased rates more aggressively than any other policy maker in Asia this year to cool inflation as gross domestic product grew 8.8 percent last quarter from a year earlier, the most among major economies after China and Brazil.

India’s benchmark wholesale-price index rose 8.5 percent in August from a year earlier after July’s 9.8 percent gain, calculated using a new base year, the commerce ministry said in New Delhi on Sept. 14.

While inflation fell below 10 percent in July for the first time in six months, consumer prices paid by industrial and farm workers in India are rising faster than 11 percent, the most after flood-hit Pakistan among the 17 countries in the Asia. The consumer inflation rate is 3.1 percent in Australia, 4 percent in the Philippines, and 1.9 percent in Malaysia.

India’s 10-year bonds declined, pushing yields higher, after the central bank raised interest rates yesterday for the fifth time this year to combat inflation. The yield on the 7.80 percent note due May 2020 rose 1 basis point to 7.96 percent, according to the central bank’s trading system. The rupee, up 0.8 percent this year against the dollar, gained 0.5 percent to 46.1550.

Government Auction

The government’s borrowing cost at the auction of 364-day bills has risen 136 basis points, or 1.36 percentage point, since the central bank started tightening on March 19. The extra yield investors demand to hold corporate bonds rather than similar-maturity government notes signal lower borrowing costs for companies. The spread for five-year securities has dropped by almost 50 percent in the past year to 77 basis points, according to data compiled by Bloomberg.

“The current level of monetary policy tightening may not be enough to slow demand growth significantly, as the still relatively low cost of capital could continue to fuel credit demand in the economy,” said Frederic Neumann, co-head of Asian economic research in Hong Kong at HSBC Holdings Plc.

Rising Demand

Banks will review their base lending rates by the end of this quarter, Arun Kaul, chairman of state-run UCO Bank, said yesterday from the eastern city of Kolkata.

Maruti Suzuki India Ltd., the country’s biggest carmaker, is among companies charging more for their products as demand outstripped capacity. The New Delhi-based automaker, which sold a record 104,791 vehicles last month, raised prices by as much as 7,500 rupees on Aug. 2. The average wholesale-price inflation rate in India rose sixfold this year to about 10 percent.

“I don’t think the rate increase will impact our sales given the fact that income levels are rising and a 25 basis points increase can be absorbed,” said Ajay Seth, Chief Financial Officer, Maruti Suzuki India Ltd. “It will not have any significant impact.”

Videocon Industries, a maker of television and mobile phones, raised 20 billion rupees from term loans maturing in 2012 this week, data compiled by Bloomberg show. Bangalore International Airport Ltd. said it plans to raise 7 billion rupees from loans and bonds.

Credit Risk

Credit-default swaps signaled an increase in the cost of protecting against non-payment of the debt for several Indian companies since December.

Five-year swap prices based on the bonds of Reliance Industries Ltd., India’s most-valued company, climbed 26 basis points this year to 171, according to data compiled by CMA DataVision. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a government or company fail to adhere to its debt agreements.

Cash at India’s banks declined this financial year as lending grew faster than deposits. Loans climbed at an average pace of 19 percent from April through August, beating a 15 percent increase in savings, central bank data show.

Banks have been borrowing money from the Reserve Bank since May, indicating a shortage of cash. Lenders raised an average 190 billion rupees a day at the RBI’s daily money-market auctions this quarter, after lending 127 billion rupees a day in the previous three months.

Impediments

“Our transmission mechanism is improving but is yet to reach robust standards,” Subbarao said in a speech on Aug. 5 in the southern Indian city of Hyderabad. “Impediments to monetary transmission diminish our effectiveness as inflation targeters.”

In China, where the economy expanded 10.3 percent last quarter, the banking regulator is considering asking banks to add a capital adequacy ratio buffer of as much as 4 percent to shield against economic swings, a person with knowledge of the matter said Sept. 15.

China’s banks extended a record $1.4 trillion of new loans in 2009, fueling asset bubbles and concerns about bad debts.

In India, higher rates “may have an effect on the real estate industry, but only up to a certain extent,” said Pradeep Jain, chairman, Parsvnath Developers Ltd., a New Delhi-based developer.