The Hindu Business Line : Credit policy curtain raiser: Stable economy gives RBI some leeway

Given the current monetary and economic situation there is no case for reducing the interest rates. But recent events may force the hands of the central bank in making decisions.

A. Seshan

All the estimates of growth of the economy in 2007-08 available from various sources give the impression that although the growth may be lower than last year’s it would certainly be indicative of the robustness of the economy. The latest prediction of 8.9 per cent is from the Economic Advisory Council to the Prime Minister. It is quite likely that the Reserve Bank of India will retain its earlier estimate of 8.5 per cent in its third quarter review of the economy to be released on January 29.

Due to the inflow of foreign capital, the growth of M3 continues to be high. As on January 4 it was at 22.4 per cent (year-on-year), much above the targeted rate of 17-17.5 per cent. The annual growth in reserve money was 27.7 per cent as of January 11, compared with 16.9 per cent last year. Thanks to various measures taken by the central bank, credit growth decelerated substantially to 21.5 per cent on January 4 from 30.8 per cent a year ago. As a result, the investments of banks in government securities went up to nearly 32 per cent of deposit liabilities as against the statutory minimum of 25 per cent.

Inflation

Inflation, as measured by the Wholesale Price Index, continues to be below 4 per cent, providing comfort to policy-makers, although the indices for consumers have been above 5 per cent. The authorities are right in worrying about inflation although there are maverick economists who claim that the problem does not exist and it is time to loosen up the policy. Today, the big problem facing the average consumer is not percentage increases in prices but their levels. When a banana sells at Rs 2 apiece what is the relevance of a 4-per-cent-inflation rate?

At his meeting with the chiefs of commercial banks in the public sector early in January, the Finance Minister expressed his desire for a cut in interest rates. Obviously, it would imply not only reductions in lending rates but also those of deposits. The forthcoming Assembly elections in several States in 2008, some of which are large in size, lend an air of urgency to the issue.

Given the current monetary and general economic situation there is no case for reducing the interest rates. But, more than the pressure from the Government, recent events are forcing the hands of the central bank in making decisions. The need for assuring the market of adequate liquidity in the context of the steep fall in stock indices, is an important development. The RBI may have to relax the restrictions on bank lending against stocks. The 75-basis-point cut in the US Fed rate is another major factor with implications for inflow of foreign capital due to external commercial borrowings and the carry-trade, and consequent rupee appreciation.

There is even a prospect of another cut in the Fed rate soon. Under the circumstances, the central bank may decrease the repo and reverse repo rates between 25 and 50 basis points. It may, however, keep the Cash Reserve Ratio unchanged, given the excess liquidity in the system. The RBI may announce the measures even before January 29.

The limitations

The monetary policy has its own limitations. When the system is flush with liquidity and banks are not dependent on the RBI, as is the case now, the latter’s influence is weak. Whether the banks would reduce their lending rates depends on their assessment of individual portfolios and, in particular, the asset-liability mismatch. More than one bank chairman has indicated that any decline in lending rates could take place only after March as all thoughts are focused on the balance-sheet. There is always the pressure to meet deposit targets and every bank wants to claim that it has done better than the system, something that is statistically impossible! In fact, the recent signals have been somewhat confusing. While some banks reduced the deposit rates, State Bank of India, the pace-setter, raised them for term deposits. As stated earlier, it may have something to do with its asset-liability balance.

Since the Government has completed its borrowing programme, the pressure on banks coming from the securities auctions will be absent in the remaining weeks of the current fiscal. On the other hand, banks seem to have factored in a reduction in the rate at the next policy review and are fishing for some treasury gains by increasing their investments in securities.

Savings vs rates

The Cash Reserve Ratio can always be raised further if there is a runaway expansion of credit. (China raised it recently to 15 per cent.) Depositors may be unhappy if they get lower rates. But it is not likely to affect savings. There is enough statistical evidence to show that saving in the Indian economy is a function of income.

National savings went up despite reductions in deposit rates. The rate of interest determines only the avenues of investment of savings, as evidenced, for example, by the fall in the resources mopped up by the schemes of government through post-offices and other sources due to better returns obtained elsewhere.

If there is one area where the RBI’s administrative action is justified it is in respect of the interest rate on credit card. While one understands the logic that the rate reflects the inherent risks involved in lending clean loans the question is how high it could be.

We are living in a consumer age. There is considerable amount of conspicuous consumption with pressures mounting on the head of the family to buy what would have been once considered unaffordable luxury goods for the middle class like the refrigerator, air-conditioner and now the mobile phone, the last accounting for as many as 200 million customers now.

Credit card defaults

In this milieu, lendings on credit cards are likely to record accelerated growth in the coming years. The problem of defaults is raising its ugly head aggravated by high interest rates. We have read about the coercive, violent and extra-legal tactics adopted by collection agents of some banks to recover loans. It necessitated intervention by the RBI.

We hear about highly indebted farmers committing suicides. The day is not far off when a similar situation may arise for credit card borrowers.

The RBI needs to act quickly in the matter of prescribing a ceiling on the credit card rates. As an alternative, the Indian Banks Association can evolve a consensus and fix the maximum. It should give some thought to the roller-coaster ride of interest rates in the call money market every now and then. It would appear that some banks lend in the morning and then, finding themselves short of resources, borrow in the afternoon leading to volatility in rates.

One does not know why the central bank discontinued the daily second session under the Liquidity Adjustment Facility. Its revival will help to keep the rates in the desired corridor.

This became evident recently when the RBI held an ad hoc second session after the rate in the market had gone up to 75 per cent. Its action brought it down to 7.75 per cent, the official repo rate.

(The author is a former Officer-in-Charge of the Department of Economic Analysis and Policy of the Reserve Bank of India. The views expressed are personal.)

More Stories on : Credit Policy | Insight

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
How ratings can help urban local bodies raise funds

Not really decoupled

‘Agflation’ — reversal of a global trend

Dilly-dallying over Lok Pal

Credit policy curtain raiser: Stable economy gives RBI some leeway

Commodity spreads: Less risky, less speculative

SBI consolidation