A letter written last week by a senior Finance Ministry official to the heads of public sector banks asking them to refer their decisions to hike the lending rates to their boards has, predictably, set off a controversy. The Union Finance Minister, P. Chidambaram, has maintained that the Government, as the majority shareholder of these banks, was well within its rights to convey its views. In effect, the Government's advice is more in the nature of a directive and therefore contrary to the letter and spirit of the reform agenda that earned for the government-owned banks a large measure of autonomy. When they put up the lending rates, these banks were only responding many say belatedly to a rise in the general level of interest rates not just in India but elsewhere too. In the latest quarterly review of its monetary policy, the Reserve Bank of India signalled higher bank interest rates by marking up the short-term repo rates for the second time in as many months. All major central banks, including the U.S. Federal Reserve, Bank of Japan and, more recently, the Bank of England and the European Central Bank, have been raising their benchmark interest rates. For monetary authorities everywhere, inflation is a big threat. One major reason has been the high global oil prices that show no sign of climbing down from their current $75-a-barrel level. Citing this and a few other factors as impinging on price stability, the RBI has called for policy measures to contain inflation within a range of 5 to 5.5 per cent. A higher interest rate regime to dampen inflation expectations is a typical monetary response and there were indications that the Government and the central bank were on the same wavelength. In its annual statement (April 18), the RBI called for a moderation in the explosive 30 per cent-plus growth non-food credit recorded last year and the year before. Fuelled by cheap bank loans, certain sectors such as housing have been showing the characteristics of a bubble.
There is ample evidence to show that higher interest rates, by themselves, will not derail economic growth an apprehension that seems to have weighed with the Government. On the other hand, keeping interest rates artificially low even at a time when they are market-determined can be harmful on a number of counts. It will mean reduced profitability for financial institutions and banks, as their "spread" income will fall. They may be unable to reward their depositors better. Banks and other financial institutions outside the government-fold will have the advantage of being able to price their risks more rationally. In line with corporate governance standards, decisions such as those relating to interest rates are taken by specially appointed committees. Economic reform has considerably strengthened the financial sector and there is every reason to continue with the process. It may be unrealistic to expect the Government to stay away totally from public sector institutions but the latest "advice" represents a brazen disregard of their proclaimed autonomy.