Banks expect interest rates to stay elevated

Banks see interest rates staying at the current elevated levels for now. The country's largest lender, State Bank of India (SBI), has extended its 9.5 per cent special deposit scheme by another month and Bank of India (BoI) has raised its deposit rates by up to 75 basis points to be on par with other banks - a clear indication of banks' expectations of a pause in further monetary tightening but not an end to it.

The decisions of the two banks are in the backdrop of an expected increase in demand for credit after the current lull, which is considered only temporary.

The increase in demand for credit over the next couple of months is likely to lead banks into another round of mad rush for resources, which could see upward pressure on deposit rates.

A senior BoI official said, "We do not want to be a part of the intense competition when banks begin to raise funds timed with the rise in credit demand from October. The bank expects to mobilise about Rs 16,000 crore through term deposits and low cost deposits (savings and current accounts) by the end of September 2006."

The softening of inflation in the past few weeks to below the Reserve Bank of India's (RBI) 5 per cent forecast for 2007-08 and the moderation in credit growth has lessened the urgency for draining the excess liquidity, which fuels inflationary expectations.

JP Morgan Chase in a note titled 'Making Sense of Volatility in Money Market Rates', said, "We believe the combination of the RBI's recent policy choices constrains its ability to fine-tune liquidity management over the very short-term, and, accordingly, the central bank tolerates transitory liquidity surpluses."

The overnight call money rate today again dipped closer to zero per cent, a trend which began in late May. The excess liquidity is also causing the market yields on government bonds to be much below the cut-off yields at bond auctions conducted by the RBI.

The flow of deposits at the country's largest bank has been about Rs 4,000 crore per month this year under various retail deposit schemes, which would add up to close to Rs 50,000 crore a year.

"We can raise deposits at 9.25-9.5 per cent against 10-11 per cent in the bulk deposit market. SBI's certificates of deposits limit is at Rs 5,000 crore. Certificates of deposits are slightly cheaper than bulk deposits. One year bulk deposits are above 10 per cent, whereas certificates of deposits are at 9.5-9.6 per cent. This has happened over the last one-and-a-half months. We are in favour of raising resources through CDs," a senior SBI official said.

SBI offers its peak deposit rate of 9.5 on 550-day deposits, while BoI pays 9.5 per cent to deposits of one year to less than three years, which is up 50 basis points from a fortnight ago.

Punjab National Bank (PNB), which saw a drop in its net profit in the fourth quarter of 2006-07, has withdrawn its special deposit scheme to contain the rising cost of resources.

The bank's chairman, K C Chakrabarty, in an interview earlier this week, said, "There is no question of interest rates going down. Demand for credit has not slowed. Only credit requirements for speculative purposes have definitely come down."

Interest rates globally are also hardening. The European Central Bank raised the repo rate by 25 basis points to 4 per cent early last month. The Bank of England today increased the official bank rate by 25 basis points to 5.75 per cent.