A lucid statement on macro economy

WATCHFULL: Reserve Bank of India headquarters in Mumbai.

WATCHFULL: Reserve Bank of India headquarters in Mumbai.   | Photo Credit: — FILE PHOTO

The ‘credit shy’ banks are averse to lend at a time economic growth is slackening

The RBI’s recent review explains why despite strong signals banks’ lending rates have not come down.

The Reserve Bank of India’s third quarter review of the annual monetary and credit policy is an impressive statement on the macro economy. By not reducing either the policy repo rates or the cash reserve ratio, the RBI might have disappointed some who were clamouring for even more robust signals than what it has been sending out since October last.

In a way, the sweeping monetary measures since October by themselves might have fuelled expectations of more ‘drastic’ cuts to shake the banking system, as it were, to lend more. It is a different matter that the already ‘credit shy’ banks have become even more averse to lend at a time economic growth is definitely slackening. A whole range of sectors, including small and medium enterprises and exporters, are reportedly not getting the support they need from banks. The chances of even existing loans, leave alone new ones, turning bad are perceived to be high.

Given the accountability factor in public sector banks with their vigilance oversight and other related issues, it will be a brave banker who will risk his career for the sake of lending to sectors which, even according to official prognosis, may not fare well.

Unless the RBI and the government explicitly recognise the existence of these blocks to commercial decision making, the diagnosis of the problem of credit delivery will be incomplete. It follows that remedial measures such as flooding the system with liquidity or massive interest rate cuts will be of little consequence.

Looser policies

The RBI has been loosening the monetary policy since September. Through rapid reductions spread over the next few months, the repo rate and the reverse repo rate have been brought down to 5.5 per cent and 4 per cent, respectively, and the CRR to 5 per cent. Such cuts have been massive and, according to the central bank, are sufficient for the time being.

Unlike its counterparts in the developed world which have brought down interest rates to historically low levels and run out of monetary ammunition, the RBI still has some elbow room to lower rates. The two stimulus packages announced so far have depended largely on monetary measures and any future package is unlikely to be different. The fiscal policy is constrained by the levels of deficits already incurred. According to the RBI, the revenue deficit and the gross fiscal deficit were significantly higher in April-November 2008 as compared to the corresponding period a year ago.

Another reason why the RBI has not altered the interest rates has, of course, a lot to do with the huge amount of liquidity — according to the RBI, Rs. 3,88,045 crore — that has been (or will be) released into the system since mid-September last year. The four percentage point reduction in the CRR will release Rs. 1,60,000 crore. On January 2, 2009, the growth in non-food credit at 23.9 per cent was higher than the 22 per cent on January 4, 2008. During the same period, the incremental credit-deposit ratio had also gone up to 81.4 per cent from 63 per cent.

Despite the expansion in bank credit there has been a perception of non-availability. The RBI attributes this to reduced flow of funds from non-banking sources, notably the stock market and external commercial borrowings. Indeed, during 2008-09, the total flow of resources to the commercial sector from banks and other sources has been marginally lower than in the previous year.

Hence, in RBI’s view the year-on-year increase in non-food credit as of December reflects the ‘substitution’ effect of other sources of funding by bank credit. Not surprising at all, the RBI observes that public sector banks have been in the forefront of both making loans and mobilising deposits. Government ownership has proved to be a big advantage in these troubled times. The shares of foreign banks and private sector banks in deposits and advances have declined appreciably during 2008.

Slow response

The RBI attributes the relatively slow response to interest rate changes from the credit market to ‘structural factors’. Savings bank interest rates are still fixed administratively and that possibly sets a floor to deposit rates. Two, a substantial portion of bank deposits is mobilised at fixed rates. Banks do not have the option to reset the rates at lower levels at a time of falling interest rates. Three, due to competition banks might have bid up the cost of deposits, especially large deposits. Four, since concessional lending rates are often linked to the banks’ PLRs, overall lending rates are less flexible. Five, the large government borrowing programme hardens interest rates expectations. Finally, during a period of high risk aversion, interest rates tend to remain high.

Inflation and growth

As always the RBI’s views on inflation and growth matter and are widely watched. In its mid-year review of October, it had estimated the GDP growth for 2008-09 to be between 7.5 and 8 per cent. In its recent review of the monetary policy, it has lowered the forecast to 7 per cent and has also warned of the possibility of a further lowering. The central bank attributes it to slowdown of industrial activity and lower exports. The services sector is likely to decelerate further. The RBI’s revised forecast is in line with most recent official forecasts. The Prime Minister’s Economic Advisory Council had very recently estimated GDP growth at 7.1 per cent for this year.

Inflation as measured by the Wholesale Price Index has already come down to below 7 per cent, a level that the RBI had expected only by march-end. Inflation is expected to moderate further to come down to below 3 per cent by end-march. However, inflation as measured by the various consumer price indices is still in double digits due to the firm trend in prices of food articles and the higher weights given to this group in the indices.


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