Mid-term review: Credit policy 2003-04

World Money

There's been no dearth of analysis and commentary on Reserve Bank of India (RBI) Governor Y V Reddy's statement last week. The benchmark 10-year G-sec yield that went up to about 5.25 per cent, in the wake of the statement, has since dropped back.

And traders have resumed speculation about further yield falls. The yield curve remains as flat as it was and, for me at least, the yield difference between one-year and 10-year paper is a poor reward for the significantly higher interest rate risk.

Talking of interest rate risk, one of my bete noires, namely Reddy's repeated exhortations to banks to change to floating rate deposits, did not find a direct mention.

To be sure, the Senore committee recommendations on the subject are under examination. (My criticism of floating rate deposits arises from the fact that such deposits will further worsen the gaps in the rupee interest rate book, where at the longer end most of the public sector banks are hugely overweight in fixed interest assets).

But let me now turn to a couple of issues in last week's statement. The first one is that "all foreign currency loans by banks above $ 10 million can be extended only on the basis of a well laid out policy of the Board to ensure hedging".

One has heard differing opinions as to which "board" is being referred to "" that of the lending bank's, or of the borrowing company's (presumably both!). This apart, exceptions have been made where:

"Forex loans are extended to finance exports", and "customers have uncovered receivables to cover the loan amount". One is not clear whether the reference is to short-term, working capital finance or for medium-term loans to finance export-oriented capex as well.

In the latter case, the stipulation that receivables should exceed the amount of the loan seems unduly restrictive. More importantly, in my view, economic exposures should also be eligible for the same treatment as unhedged export receivables.

The issue is all the more important when the rupee has been appreciating, and there is no other way, except a foreign currency loan, to hedge long economic exposures in the form of output whose prices in the domestic market are governed by the exchange rate.

Such businesses cover all commodity output industry, including ferrous and non-ferrous metals and basic and petrochemicals. As it is, the issue of economic exposures to exchange rate variation is not as well appreciated by company managements (and often their bankers), and treating them on par with unhedged exports in the RBI statement would have helped increase awareness.

"Forex loans are extended for meeting forex expenditure." The logic beats me completely. First, is the reference to revenue expenditure or to capital expenditure? Surely, the two cannot be treated on par?

Again, the use for which foreign currency borrowings have been put to (local or forex expenditure) is completely irrelevant to the management of the exchange risk on the loan. What is relevant is the currency of future cash flows.

For example, a foreign currency loan for constructing a factory building by a company with long economic exposures is entirely different, for risk management purposes, from one taken to import raw materials for manufacture of products for the domestic market. The first one does not need much hedging; the second one needs a very conservative policy.

In short, as far as this point is concerned, the policy statement perhaps leaves room for conceptual clarity and more rigorous articulation.

The second point I would like to touch upon is the benchmark prime lending rate (PLR). The intention seems to be to bring down the PLR because, first, the fall in PLRs has been nowhere near the fall in bond yields. Second, since 90 per cent of businesses do not have access to bond markets, they are benefiting but little from the general fall in interest rates.

On first principles, an unduly high PLR will get reflected in either higher net interest income as a percentage of total assets or an unduly high operating profit. If there is any evidence of this it has not been cited. The system-wide data available in the public domain is the RBI's Report on Trend and Progress of Banking. Unfortunately, the report for 2002-03 has not yet come out.

In the previous year, the data pertaining to public sector banks does not evidence usurious interest rates. The net interest income as a percentage of total assets was 2.73 per cent, at the lower end of the previous five years range (2.70 to 3.16 per cent). There was a sharp fall in operating expenses to 2.29 per cent from a level of 2.72 per cent in 2000-01, and a five-year range of 2.66 to 2.88 per cent.

The gross profit was higher at 1.88 per cent compared to the previous five years, but mostly because of a fall in operating expenses rather than a rise in the net interest income. Indeed, in both 2000-01 and 2001-02, the net profit was only a little higher than "other income".

If there is not much change in these macro numbers in 2002-03, a drop in PLR would be affordable only through a downward revision in deposit rates. This will not be very welcome to a major and vocal constituency, and goes against the lack of action on reducing adequately the various administered interest rates.

Email: avrco@vsnl.com