The first bi-monthly Monetary Policy Statement for 2015-16 announced on April 7 was in line with expectations. Neither the policy repo rates nor the reserve ratios — cash reserve ratio (CRR) and statutory liquidity ratio (SLR) — were changed. Ahead of the monetary statement, the consensus among important market participants was for a status quo on interest rates. A small number anticipated a CRR cut and a fewer still a reduction in the SLR.
RBI’s inaction on the monetary tools, however, did not make the policy statement a non-event. Quite the contrary, there have been a number of takeaways which in the months to come might herald significant changes in the way monetary policy will operate.
A change in the nomenclature of the statement is significant. Not very long ago, the Reserve Bank of India (RBI) used to release in April or early May an annual policy statement for the whole year covering besides monetary matters, development and regulatory issues in substantial detail. Coming a month after the Union Budget, the monetary policy was used to take note of the fiscal policy changes and their impact on the monetary economy.
This was supplemented with a half-yearly review in October. Although it has gone out of fashion now, the annual policy statement in April used to be called the ‘slack’ season statement, while the half-yearly policy statement in October was meant to take care of the ‘busy’ season requirements. The fundamental changes in the structure of the Indian economy have made the age-old distinctions between busy and slack season obsolete. Agriculture contributes less to the GDP than industry and services.
The need to increase the frequency of interactions with the financial markets necessitated policy statement releases at shorter intervals — at one stage once in 45 days. Even then, the April statement enjoyed a degree of primacy. However, following the Urjit Patel committee’s recommendations, bi-monthly policy statements have been the norm.
Turning to the latest statement, if status quo was widely anticipated what is new or unexpected? An interest rate cut, it was widely believed, would not happen because of the feared impact of adverse weather conditions on the rabi crop. Of particular concern has been the volatile vegetable prices. Even granting that these are ‘supply side’ causes, not usually amenable to monetary policy action, retail inflation — the new benchmark — has been inching up lately, though well within the RBI comfort zone.
The real reason for RBI holding out may be something that is inferred from the statement as well as the Governor’s articulation at the post-policy conferences. Although a blunt explanation may not do justice to a nuanced policy which the monetary policy is, it is certain that the RBI would wait for banks to pass on the benefits of the earlier rate cuts before effecting new ones.
That squarely brings into focus the problem of inadequate monetary transmission — the inability or unwillingness of banks to respond to monetary actions. Banks have their own problems. The chairperson of State Bank of India, the country’s biggest bank, had said that the perception that interest rates would go down had made several depositors shift from the relatively inexpensive savings and current accounts to term deposits. Moreover, banks arrive at their cost of funds taking into account several parameters such as market borrowing, pattern of credit disbursements and so on.
Banks’ dilemma
The issues raised from the dilemma may not be as stark as one PSB Chairman pointed out. Short-term repo rates are one but not the most important determinant of commercial lending rates. For all government-owned banks, the deposit rates they offer may be more crucial. However, squeezing the deposit rates and fall in line with RBI’s expectation is far from being realistic. Previous credit policies have highlighted depositors’ concerns, and nothing has changed since then to downgrade them. RBI Governor Raghuram Rajan hopes that competition among banks for quality business will force interest rates down. However, in the past, banks were forced to offer sub-optimal rates to highly rated customers with borrowers at the other end of the spectrum not getting the treatment they deserve.
As for the suggestion to calculate their cost of funds on the basis of marginal costs, (rather than the present average costs), a few private banks have pointed out that there are deficiencies in India’s financial structure that make such calculation difficult except over the medium term.
Transmission by force
By far, the most important message from the policy statement is that the central bank is not averse to persuade banks to lower their rates. In conjunction with the better known pressures from the government, monetary transmission might be driven by executive fiat rather than market forces. That, as every one interested in sectoral reforms will vouch for, is not a good thing.
