Chanda Kochhar, managing director and CEO of ICICI Bank, expects interest rates to rise next year but only gradually, as credit growth returns to part-fund an estimated $350 billion of investment pipeline from different sectors that are lined up for implementation over the next two-and-a-half years. In an interview with Manju AB and Rajendra M Palande, Kochhar said the country’s second largest bank will return to growth path from the next quarter driven by home loans and project finance businesses. Excerpts:

What’s your outlook on hardening of interest rates?

Interest rates will go up next year. But it will be a smooth gradual rise. I do not expect a sharp increase. There will not be a lumpy increase, nothing that will derail the investment cycle. Even RBI is very clear that it wants a balance between inflation and growth, and they will not take a one-sided view with excessive tightening at the cost of growth.

What kind of credit growth will the banking system see in 2009-10?

In the first seven to eight months of the present financial year, the credit offtake was poor and in the next quarter, I expect only a gradual pickup. There is a lag between sanctions and disbursals. But next year I foresee bank credit growth in the upwards of 20 per cent.

What role will banks play in the growth story?

Banking has to play a very big role in the (current phase of) economic growth. Banks will have their hands full to make this happen. There are two drivers of growth — first is domestic consumption, which we saw in the whole of last year. And second, investments (by companies) are coming back. Lots of companies are talking of new projects and all the projects that were on the backburner are now back. The active project pipeline is $250 billion. These projects will get implemented over the next two-and-a-half years. The banks will have an important role to play both in terms of project finance and meeting demand for domestic retail credit such as home loans and car loans.

GDP is growing at 7.9 per cent, but bank credit growth is still subdued at 10.5 per cent?

GDP has been kickstarted because the consumption was strong and investment activity is starting. Companies are not really using bank finance for investments. Companies are finalising projects, arriving at financial closures and making initial commitments. The initial commitments are getting made either by opening LCs (letters of credit) or the money is coming from the capital market with so many of them having raised equity. Many of them have also raised funds overseas because foreign markets have opened a little bit. After these sources are used, companies will start using bank finance. Unlike in the past, companies are no longer using bank credit first. That is why you see the dichotomy of credit growth being low while economic growth is picking up. But all the signals for credit growth to pick up in the next year are in place.

Or is it because banks are wary of lending to certain sectors?

No. Banks are not wary of lending. I think banks are not just lending, they are doing so at very competitive rates across products. If you see our own approvals or sanctions, in the second quarter (ended September 30) approvals were double than those in the first quarter. Banks are approving loans and financial closures have begun, but the draw down will happen with a lag. The third (current) quarter has been better than the second quarter.

Is the investment pipeline more because of some specific sectors?

The investment pipeline is across sectors, including manufacturing sector.

But a number of road projects have remained only on paper because of land acquisition issues?

The government is doing a lot for the roads sector. The government has decided that new projects will be out for bidding only after they have acquired more than 90 per cent of the land required so that the project does not remain only on paper. The government is also changing the covenants and the model concession agreement to speed up road projects. I expect a lot of investment in roads and highways segment to happen. Then, the power sector is another infrastructure segment where investments are moving.

What about retail growth?

On the retail side, the segments that are moving are housing and car loans. Car loan demand continued to remain pretty high even during difficult months of last year. In housing, after the slump from December (2008) to July this year, the demand is again back. There is an increase in home loan registrations.

Many real estate developers are cash-strapped. Is there any risk for banks?

Banks’ direct exposure to developers is very low. Our exposure will be around Rs 4,000 to Rs 5,000 crore. Real estate should be divided into three parts — residential property, commercial property and retail malls. Residential property has no risk at all. Inherently, there is large demand and the supply will not exceed demand. The office segment is not rosy and demand will remain muted for the next two years as supply is in excess of demand. But the stress is not huge enough to pull any developer down under. Some have raised equity and these funds will see them through. Malls are a drag for the developers and this segment will see maximum stress.

Demand for working capital has shrunk as efficiencies have improved since the crisis. Will it be a drag on credit demand?

It is going to be a fact that credit growth is not going to come from increased working capital cycles. It is going to come from investments that companies make for growth. Companies would focus on improved efficiencies.

Will banks be able to meet the huge demand for project finance?

Banks have an important role. Domestic banks are no longer the only source of funds. There is equity capital, internal cash accruals, domestic funding and international funding. There is today healthy availability of liquidity across all these four streams.

What if Libor goes up? Is there a risk you see for companies raising funds in foreign currency?

At present, funds are so cheap overseas, even if the cost goes up a few notches, it will not be a risk. Overseas borrowing is a decent source of funding. Besides, they can hedge the risk of interest rates by building in swaps.

At what point will the banking system start feeling the liquidity pinch?

I don’t think banks are feeling the potential liquidity crunch. Banks have deployed excess liquidity for the short term. Once the credit pick happens, the existing excess liquidity is very small, it can be sucked out very fast. Over the next financial year, all this liquidity will get sucked up quickly.

ICICI Bank's balance sheet has been shrinking for nearly two years now. When do you expect it to start growing?

For the past one year, we have been very focused on certain sectors such as project finance and housing loans. We brought down unsecured lending, but the businesses that we were focused on did not grow at the pace we envisaged due to external factors. Companies were not setting up projects and individuals were postponing their decisions to buy homes. But our policy remains consistent in that we want to reduce unsecured lending and grow corporate and mortgage businesses. The growth in these businesses will overtake the repayments in the unsecured loans.

How important will be the unsecured lending in the overall retail portfolio?

Aggressive customer acquisition for standalone products like credit cards and personal loans will not be there. These products will mostly be for our in-house customers. We will be very focused on saving bank account and current account customers. We will start a relationship and then sell other products. Unsecured lending had gone up to 17 per cent of the over all retail credit portfolio. We will bring it down to 7 to 8 per cent. We are targeting this mix.

What is happening in the bank's international book?

Not much. The level of operations is stable. There is nominal growth in assisting Indian companies raise funds overseas. Indian companies are not bullish on growing overseas. There will be single-digit growth with stable operations.