The latest credit policy statement of the Reserve Bank of India (RBI) for the current financial year was devoid of any surprises. A 25 basis point reduction in the policy repo rate to 7.5 per cent has been the only monetary measure. Even this was widely expected.

There were fewer expectations of a CRR (cash reserve ratio) cut but the RBI did not oblige presumably because it expects the current strained liquidity conditions to ease.

Besides, the central bank will inject liquidity through open market operations.

The CRR remains at an all time low of 4 per cent. Many bankers, led by SBI Chairman, feel that the CRR needs to be done away with. The reasoning is that the bank funds kept impounded with the RBI earn little or no interest. Its use as a policy instrument is questionable in a vastly changed environment. In any case, banking reforms aim to do away with the CRR and the other statutory pre-emption, statutory liquidity ratio (SLR). But right now, the CRR cut, which did not happen, is in the news for another reason. Many bankers feel that a reduction in the CRR rather than the repo rates by 0.25 percentage point would have enabled them to reduce their lending rates.

Transmission mechanism

This brings into focus the inadequacy of the transmission mechanism in India. Unlike in the developed markets, a reduction (or increase) in the policy rate do not have an immediate impact on market interest rates.

One reason is that Indian banks are dependent to a greater degree on deposits rather than on money market to fund their loans.

For banks to retain their interest margin (the difference between interest receivable on advances and that payable to depositors), a repo rate cut, if transmitted, should mean lower rates on not only loans but also on deposits. If banks lower the lending rates alone, their spread income will come under pressure. But, in the present context, where deposit growth with banks has been lagging behind credit growth, banks cannot afford to lower deposit interest rates. It is pertinent to note that banks find it increasingly difficult to build up deposits even with the existing rates.

After the last policy announcement in January when the repo rate and the CRR were reduced, some leading banks actually hiked their deposit rates, although the gesture appeared symbolic. This should highlight the neglect of depositors by banks and policymakers.

In a macro sense, the flight of household savings to non-financial investments (read gold, real estate and the like) is a big worry. The Union Budget sought to incentivise investments in financial instruments.

A new inflation-linked deposit scheme was proposed, among others.

It seems likely that the Annual Credit policy for 2013-14 due in May would have some concrete proposals in this direction. Hopefully, it will take a holistic view of depositors’ problems, especially of those totally dependent on interest income from deposits and not be confined to profitability issues of banks.

One other issue that is sure to be discussed at greater length in the annual policy statement is the relevance of interest rates on growth. The main justification for a repo rate reduction this time has been the need to revive the economy. GDP growth during the third quarter of this year came in 4.5 per cent. For the whole year, it is not expected to be above 5 per cent. The mid-term policy review does not question the relevance of ‘competitive interest rates’ in reviving investment, without which the economy cannot move to a higher growth trajectory.

However, there are other conditions that have to be met, including bridging supply constraints, staying the course on fiscal consolidation, both in terms of quantity and quality, and improving governance.

Consistent view point

The RBI has been fairly consistent with this view point but as stated in the recent policy, it appears to be throwing the ball back into the government’s court. “We have done our bit (through a rate cut). You should carry forward fiscal consolidation and other measures.”

The other headline grabbing news from the policy — that the scope for further easing is limited — is neither surprising nor new. The message that markets should have learnt is not to take the Bank for granted.

The mid-term policy might not have broken new ground but it does identify key issues which will be carried forward in May.

narasimhan.crl@thehindu.co.in

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