Emboldened by public sector banks, State Bank of India (SBI) and Canara Bank's move of slashing prime lending rate (PLR) by 0.25 percent, India's Finance Minister P. Chidambaram has urged other state-run banks to follow suit to ensure that productive sectors of the economy are not starved of credit.

Meeting heads of public sector banks, Feb. 12, the finance minister said they should ensure credit flow to the home and consumer durables sectors, which have witnessed some slowdown in recent months.

Earlier, in a regulatory filing on Feb. 11, SBI said that the benchmark PLR would be revised downward by 0.25 percent from 12.75 percent to 12.50 percent with effect from Feb. 16.

Canara Bank also slashed its benchmark PLR by 25 basis points (or 0.25 percent) to encourage demand for credit. Cutting its PLR to 13 percent on Feb. 11, the bank said the new lending rates would be effective from Feb. 16.

While other government banks like Allahabad Bank, Bank of India (BoI) and Bank of Maharashtra (BoM) did not tamper with their PLRs, they also promised rate cuts between 0.25 percent and 2.5 percent on selective retail loans like housing, education and a few consumer loans.

India's largest mortgage lender HDFC also reduced its retail prime lending rates (RPLR) by 0.25 percent with effect from Feb. 1 and PNB (Punjab National Bank) Housing Finance followed suit by reducing interest rate on housing loan by 0.5 percent.

In line with many other public sector banks, State Bank of Bikaner and Jaipur (SBBJ) on Tuesday also announced a cut in home loan rates between 0.25 percent and 1.25 percent with immediate effect.

UCO Bank and Indian Overseas Bank (IOB) are also expected to reduce PLR by 0.25 percent after their asset-liability committee (ALCO) meeting later this week.

Since October 2004, the Reserve Bank of India (RBI) had raised benchmark rates nine times to make loans more expensive and rein in inflation.

But the credit squeeze enforced by the RBI has hit the growth of two sectors – housing and consumer goods - over the last 12 months.

According to Chidambaram, the credit squeeze by RBI was a conscious move to rein credit growth, but if it slows down too much, it will affect economic growth.

There has been a slowing down of credit growth. However, this slowing down of credit has indeed, to some extent, affected flow of credit in the housing sector and consumer durables sector. There is a feeling that adequate credit is not being provided to the housing sector and the consumer durables sector, Chidambaram told reporters after a review meeting with the heads of the public sector banks. Banks have been asked to pay attention to provide adequate credit to these two sectors as they are drivers of the economy.

The government has sensitized banks to the demand of the consuming public, he said, adding that some banks have already begun moving in that direction.

Consciously over a period of a year there has been a slowing down of credit growth. But the banks ensured that that slowing down did not affect the productive sector. I have made this clear in the past that the productive sector should not be starved of credit. I think they have kept that principle in mind, productive sectors have not been starved of credit, the finance minister said.

Banks have been advised to pay attention to the requirements of credit for home owners and requirement of credit for those who would like to buy consumer durables and consumer non-durables. The reason is that consumer drives production and production drives investment. Therefore, one must ensure that there is adequate growth in consumption also, he added.

On an earlier occasion, Chidambaram, after meeting bankers on Jan. 4, had underlined the need to cut deposit and lending rates by half a percent to spur investment and consumption so that the economy could be sustained on a high growth path.

I would like, I can't wish this, that banks cut lending and deposit rates by 50 basis points (0.5 percent) so that it stimulates investment and consumption, he had said.

Though most public sector banks are expected to follow the finance minister's suggestion, the same cannot be said for private sector banks.

India's largest private sector bank, ICICI Bank said that it would continue to monitor the impact on its cost of funds and take a suitable decision.

Why should the bank cut PLR when the latest inflation rates have risen to 4.11 percent from 3.9 percent? asked a senior banker at a private bank.

What signals are being seen by SBI and Canara that we don't see? wondered another banker at a foreign bank. Nobody is hinting at a CRR (Cash Reserve Ratio) or SLR (Statutory Liquidity Ratio) cut.

However, analysts feel banks are slashing rates so that demand increases for borrowed loans from the consumer and, from the industry point of view, increase in consumption means increase in production and increase in production means increase in investment across the industries.

If more loans are borrowed there will be increased circulation of money in the system, resulting in growth in industry, an analyst at a top public sector bank said.

The effects of weak global markets and US economic slowdown are being felt in India and statistics available with RBI show that year-on-year credit growth of public sector banks has slowed to 22.6 percent as on January 25, 2008 from 29.8 percent a year ago.

Credit squeeze and high interest rates have impacted the Indian economy of late and the government recently announced that the economy would grow at 8.7 percent this financial year as opposed to last year's growth of nine percent.

Industry-wise credit growth has fallen. The feeling is that it will be difficult to see 20 percent credit growth year-on-year, from the current levels of 14 percent. So, this move by SBI was expected, said Chandana Jha, a banking analyst from PINC Research.

We have taken the decision against the backdrop of softening of interest rates (as seen in the yields). This cut will provide benefit to clients across the board and also push credit demand in the fourth quarter ending March 2008, a senior SBI official said.

There is a general feeling that interest rates are high, which is also evident in the slowdown in credit offtake. We expect the reduction in rates will improve our credit growth, he said.

The impact on net interest margin will be negligible, he added.

Indian Banks' Association chairman M.B.N. Rao agrees. According to Rao, a further reduction in interest rates could be expected due to sufficient liquidity in the system. If the trend continues, then interest rates may fall, subject to RBI guidelines, he said.