Crude shock: Deeper crisis in Yemen could mean your loan rates won't fall as expected

Fresh signs of tensions emerging in Southwest Asia, where a Saudi Arabia-led coalition has begun airstrikes on Yemen rebels, have raised worries of a potential spike in crude oil prices, which will have a ripple effect on oil importing countries like India. Yemen isn’t an oil producer but it is a strategic supply route for oil imports for many countries. Yemen controls straits through which many oil containers pass, hence tensions in the region could result in serious disruptions and fuel price spikes. This is something that can upset the Reserve Bank of India (RBI), which has underlined any upward pressure on crude as a major risk factor to the ‘gliding path’ of inflation. The Mint street would want to closely watch the developments, and any worsening of the situation, might delay the planned rate cuts expected during the course of this year. [caption id=“attachment_2132471” align=“alignleft” width=“380”]  Reuters[/caption] If indeed these worries materialise, the primary affected parties will be the individual borrowers and small firms, who are desperately waiting for rate cuts to reduce their interest cost burden. As Firstpost has pointed out before, large companies are primarily shifting to cheaper corporate debt market to raise funds, rather than approaching banks, hence somewhat immune to lending rate movements at commercial banks. But that isn’t the case with small companies. Even now, most banks haven’t reduced their base rates even after the RBI slashed its repo rate, key lending rate, by a total of 50 basis points (bps) in two rounds this year, even though some of them have lowered their deposit rates, which typically should follow reduction in lending rates as well. One bps is one hundredth of a percentage point. The reason why banks haven’t yet cut their loan rates is that they want to protect their margins. A cut in loan rates would further squeeze their margins in a scenario whereas loan flow still lags behind deposit growth. At present, there is a possibility of some reduction in base rates in April on account of mounting pressure on banks to cut rates. The trigger is likely to come from State Bank of India (SBI) that will be followed up with other banks. But, if the inflation faces further upward pressure on account of the worsening of risk factors, such as crude spike, the financial markets will naturally factor in delayed rate cuts from the RBI and banks would limit their lending rate cuts to small margins. The consumer price inflation (new series with 2012 as base) has already shown an upward trend in the recent months increasing from 3.27 percent in November to 5.37 percent in February. Even if banks choose to reduce their base rates, say by 25 bps to 9.50-9.75 percent from the current 10 percent levels, any major revival in bank lending is unlikely. This wouldn’t do any magic in drastically improving the loan growth for a few reasons: First, as already mentioned above, at least for top-rated corporations, raising money in the corporate bond market is becoming a much cheaper alternative than going for expensive bank loans. Getting the issues rated and raising money from a few selected private or public investors is a much easier exercise than going through the tedious process of getting a loan sanctioned. Second, the banking system simply doesn’t appear to have the capacity to fund the large demand in the event of a pick-up in credit growth since state-run banks, which control 70 percent of the banking system are severely constrained in terms of substantial chunk of bad loans and fund-draught. To be sure, it is not that there is immediate demand from companies, which might take at least a few more quarters when most economists expect the economic recovery cycle to gather momentum. Chances of improvement on both sides — banks and companies — are fairly distant at this stage. According to a report by Kotak Institutional Equities, balance sheets are still struggling both at the (1) banks’ end with high impaired loans and low capital and (2) companies’ end with high debt deleveraging albeit very slowly. Hence, any sharp cut in lending rates may not be an adequate solution to revive demand, the report said. “Our discussions with bankers and companies suggest that the revival of the capex cycle has extended by a few more quarters with hope driving the current scenario,” the note said. Banks are hugely burdened with stressed assets on their books both in the form of bad and restructured loans. Together, such loans constitute about 11 per cent of the total bank loans given in the system. Such huge pile of sticky assets has broken the back of state-run banks, excluding a few large ones, particularly in the back drop of no capital assistance from government. Third, even though the RBI has attempted to rectify the inefficiencies in the base rate system by seeking more frequent revision and consistency in the methodology, banks still enjoy significant advantage in deciding the final rate arrived on each category of borrowers by manipulating the premium above the base rate. Hence, even though banks choose to oblige with the rate signals from the central bank by cutting their base rates by a small margin, they can still choose to charge higher rate by adjusting the spread. On several occasions, the central bank has almost admitted that it doesn’t have much control in ensuring proper monetary transmission in the banking system, since it is the bank lobbies, which finally call the tune. The reality is that that the so-called victory of RBI over inflation, part of the credit for which has been duly claimed by the Narendra Modi government, is mainly on account of the slide in international crude prices, more than domestic factors. India being heavily dependent nation on imported fuel, any major external shocks can significantly upset the inflation projections and rate stance of the central bank. Crude holds the key.