Fallout of costlier loans

Some policymakers continue to insist that growth will stay the course and that GDP will expand at the expected rate of 8 per cent. Analysts too suggest a slowdown, but not one major enough to get worried about. This is indeed surprising because most indicators that matter, such as investment growth, suggest a palpable drop in economic momentum. What had helped bolster the confidence that growth would steam along was consumption growth, especially the robust expansion of sales of consumer durables. Now even that engine may run out of steam.

In its June credit policy the Reserve Bank of India had confirmed strong consumption growth but cautioned of a slow down in “interest-sensitive” sectors such as automobiles. It did not require the apex bank's insight to issue that warning as consumer lending rates were bound to move up in the wake of the RBI's own persistent increase in its key rates. The last spike may have been modest, at 25 basis points, disappointing those analysts who wanted a stricter intervention, but the effect has been evident down the line, with a slew of banks gearing up for hikes in their respective base rates. Led by the State Bank of India and ICICI Bank, the two largest banks, virtually every bank is increasing its base rate — the minimum lending rate — to cover the cost of funds that has gone up on the systematic increase in the RBI's repo rate, that more than doubled since it began its monetary tightening, and now stands at 7.5 per cent. While some banks have also increased deposit rates, most are tinkering with lending rates. The sectors that will be affected the most are precisely those that are interest-sensitive, such as housing and automobiles. If the higher cost of borrowing does affect consumption growth, especially in these two key sectors, one can expect the impact to be felt on the rest of the economy as well. Recall that the auto sector was the key driver of the ‘green shoots' recovery in 2009, after the government's expenditure and fiscal sops; the growth of auto sales and housing led to higher demand for steel and cement, and an invigorated supply-chain down the line to the consumer, reflected in higher retail sales. What is more, such sales also encouraged global auto companies to look at India as a major manufacturing hub.

With investments sluggish on account of a cloudy policy environment, consumption may now drop on account of higher cost of borrowings and the impact may be more serious than policymakers are willing to admit.