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Every rate hike over the last two years has been justified as an attempt to curb the fierce growth in retail loans that fuels inflation.
If evidence were needed that the Reserve Bank of India’s prescription for inflation control may be having some unpleasant effects, look no further than the home loan market. Leading institutions such as HDFC and ICICI Bank have raised rates 75 basis points, a quarter point above the RBI’s recent hike in repo rate and reserve requirement. HDFC’s floating rate stands at 11.75 per cent, while ICICI’s hovers above 12 per cent, after the second spike in a month. Other banks have already hiked their home loan rates, and yet others will follow. With the average prime lending rate inching toward 16 per cent, reminiscent of the mid-1990s, when it was in a similar range, it is hardly surprising that the growth in home loans has taken a hit, dipping to 12 per cent this February from 49 per cent growth four years ago.
From the central bank’s point of view, this decline is welcome; every rate hike since mid-2006 has been justified as an attempt to curb the fierce growth in housing loans, one of the key drivers of excess demand and, therefore, inflation. From the borrowers’ point of view, however, the effects have been perverse for, even as borrowing costs have escalated, housing prices have not declined. In any case, that is not going to help in the national effort to reduce the housing shortage in the country, estimated at over 24 million houses. The distorted effects do not end there; soon, interest rates on consumer loans such as auto-loans may rise but auto companies will find it difficult to reduce prices in view of their own rising input costs. Lagging demand may force companies to cut back production and growth will suffer. Lower growth may not soften prices because primary inflation is virtually imported and beyond policy control. But secondary inflation, born of the excess liquidity that exercises the RBI so much, can be managed by controlling capital inflows.
The RBI chases shadows when it assumes that liquidity can be calibrated by dear money. So long as domestic interest rates are much higher than global rates, companies will borrow more abroad, creating a copious flow that will inexorably increase domestic rupee supply. How else can the strong surge in reserve money above tolerable levels of 17 per cent be explained? Not by domestic demand for consumables or housing. The fact that home loan growth is declining and will fall further shall in no way mitigate an inflation driven by the central bank’s futile attempts to control it.
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