The Hindu Business Line : Sticky deposit, lending rates

The RBI’s third quarter Review of Monetary Policy was on expected lines — all rates and the cash reserve ratio were left untouched. It had actually moved well before the Review to ease interest rates and liquidity in a series of cuts of the reverse repo and repo rates and sterilize liquidity.

The problem is the absence of a complete passthrough of the cuts to businesses and individuals. The benefit to borrowers has, at best, been half and in the case of private sector banks not even that. One impediment is the high cost of legacy and current deposits. The other could be the fear of increases in non-performing assets in adverse business and job conditions for borrowers. In any case, deposit and lending rates are significantly sticky on the downside and must be considered a significant weakness and lack of maturity of our financial system. The difference between the US and India is that there the premium for credit risk remains stubbornly high. But deposit rates have followed Fed rates down more or less parallely.

Does the answer lie in capping deposit rates? Then lending rates also ought to be regulated. It all smacks of the bygone and unlamented era of controls.

What can the RBI do? Like the Fed and the Bank of England, it can step in and buy assets itself. If (a big ‘if’) at all this is done, it is important to do it in the primary market and influence those rates, which, in turn, will set the desired levels in the secondary market. Otherwise, the risk is that the RBI could end up as a receptacle of anything and everything that banks do not want to hold without any impact on borrowing costs.

Isn’t it way out of central banking? And what about the logistics of the RBI becoming a primary lender to business?

Of course, it needn’t come to that. Moral suasion is the traditional method of making banks fall in line with a central bank’s wishes and may well be enough.

Deposit rates must relate to the return on capital in the economy, which has plunged. In simple terms, the remuneration for savings cannot be the same irrespective of the rate of profit (in business) and (falling) the rate of inflation.

Considering the depth of woes facing the global and domestic economies, the RBI is not done with its rate cuts (which are no longer coincident with Policy Reviews).

More easing actions are in the pipeline.

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