If you have been living your life on credit, it's likely that you have acquired more than an academic interest in the annual credit policy of the Reserve Bank of India. After all, the cost of all those loans you have taken or plan to take to fund everything from house to car to washing machine depends critically on what the RBI does to interest rates. By raising what is called the reverse repo rate (see box: Interest Rate Primer) by 0.75 per cent in four instalments since May 2004, RBI Governor Y.V. Reddy has hinted to banks that they should be a little more cautious about what they are lending for, and at what rate. This has significant implications in the times when credit boom is one of the key drivers of the consumption boom which in turn has been crucial for the industrial and economic boom.

1 INFLATION PARADOX Low product prices combined with high asset prices RBI says inflation of commodity prices is low, but inflation of asset prices (e.g. real estate) is high. Message: An over inflated housing price market could be as bad as, say, inflation in onion prices. 2 INTEREST RATES Upward pressure, but no immediate hike RBI suggests banks may have cut rates on some loans too much, too soon. Message: Home loan rates may rise a bit, but not soon. Other loan rates stable. 3 LOANS Big borrowers get them easy while small entrepreneurs are ignored RBI hints that banks are under-pricing loans for big companies and over-pricing for small enterprises. Message: Cheaper loans for small entrepreneurs and a clearer definition of prime lending rate. 4 BANK ACCOUNTS No frills, but inexpensive banking services Maintaining accounts is costly. RBI wants banks to offer low balance accounts. Message: Bank should cut costs of operating accounts to reach out to the poor.

In addition to implications for economic growth, inflation and investor sentiments, the October 25 review of the credit policy has four key messages for the common man. The first one is the most basic, and yet perhaps the most profound. Reddy has warned that people's outlook on inflation may be limited. Traditionally, for the common man inflation is about prices of products and commodities he consumes-foodgrains, vegetables, consumer products, electronics, cars and fuel. Fortunately, the rise in the prices of most of these goods (barring onions and oil) has been moderate and inflation isn't a big issue.

Or is it? What about asset prices-the prices of houses and equity shares, for instance? Haven't they shot through the roof in the past two years? According to the RBI the consequences of an asset prices inflation on consumption and investment could be no less severe. If the price of a house bought for Rs 60 lakh falls to Rs 40 lakh, the loss will hit the buyer's consumption as hard, if not harder, as a high inflation would. That's for the individual. For the bank that may have given loan for the purchase of the Rs 60 lakh house, the fall in price could endanger repayment of that loan. Multiply that with millions of individuals and loans, and the consequences sound scary. That's one reason why the rbi has been somewhat anxious about the rate and quality of home loans. Since November last year it has twice raised the risk weight of loans to real estate, which has led to a 0.5-1 per cent hike in interest rates on all home loans in the past one year. "The RBI's reiteration of credit quality comes against the backdrop of steep increase in asset price-particularly in equity and real estate," says A.K. Purwar, chairman and managing director, SBI.

So is another hike in interest rates round the corner? Depends on which interest rate one is referring to. For consumer loans other than home loans, no rate revision is expected, at least not due to any measures taken in the credit policy. For home loans too, though another small hike (0.25-0.5 per cent) is being talked of, no bank is as yet ready to bet on when and how much the increase will really be. Remember, the Central bank hasn't raised the bank rate, which is the most significant signal rate in the banking system. At 6 per cent, the bank rate has remained stable for years. The minor adjustments in reverse repo rates do not point to an imminent or across the board rate hike. But banks can certainly become more choosy in granting a loan and interest rate they charge may vary from client to client or from one residential area to another. In some ways, banks have already begun to adopt a more customised approach to granting loans than they did just 2-3 years ago.

Much to the delight of small and medium entrepreneurs (SMEs), Reddy has questioned the banks' pricing of loans for big borrowers. The average rate at which banks offer loan to their best rated (prime) borrowers is called the benchmark prime lending rate (BPLR). The RBI finds that actual pricing of loans granted by banks to prime borrowers has gone way out of alignment (on the lower side) with the BPLR and that too in a non-transparent manner. "There is a public perception that there is under-pricing of credit for corporates while there could be over-pricing of lending to agriculture and SMEs," says the policy statement. While this may not be the case of robbing the poor to pay the rich-interest rate at which one gets a loan is a function of one's creditworthiness and that puts bigger and richer borrowers at an advantage-the banks have been asked to make their real PLR the declared PLR. "The corporate sector was being subsidised at the cost of other borrowers. But retail loans are not overpriced and I don't expect their interest rates to rise," says Cherian Verghese, chairman and managing director, Union Bank of India.

The catch, which the RBI doesn't talk of in the policy revision, is that once the official PLR (currently 10.25-10.75 per cent) is lowered to reflect the real PLR, banks will also have to lower the interest they charged to SMEs, because the rates offered to SME borrowers have to move within a range of the PLR. One of Reddy's concerns is also the bank's exposure to capital market. The banks' direct exposure has been capped at 20 per cent of their consolidated net worth. But there is an indirect exposure to capital markets too. There have been complaints that companies use the loans they take from banks for working capital requirement to invest in stockmarkets. So far, there is no way to regulate India Inc's exposure to the capital market through bank borrowings.

The RBI hasn't just taken care of small borrowers. It has ruled in favour of small depositors too. Requirements like maintaining a minimum balance in a savings bank account and imposing steep charges when the minimum balance is breached are preventing the expansion of banking services-or so the Central bank thinks. It has asked all banks to "make available a basic banking 'no frills' account either with 'nil' or very low minimum balance". Banks have also been asked to be more transparent in imposing charges on various services. It is Reddy's way of telling banks about the fortune at the bottom of the pyramid.

-with Malini Goyal

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