Mumbai: Indian banks were still saddled with high-cost deposits and so lending rates would only soften gradually despite big cuts in official interest rates, Reserve Bank of India (RBI) deputy governor Rakesh Mohan said on Thursday.
The RBI cut its key short-term rates by 25 basis points on Tuesday, and reiterated a call for commercial banks to pass on its aggressive rate cuts to help boost the flagging economy.
The RBI has slashed its short-term lending rate, the repo rate, by 425 basis points in six moves since October to 4.75%, but the prime lending rates of five major commercial banks have fallen less than 200 points in the same period.
“While interest rates on incremental time deposits are coming down, the average cost of deposits will remain high till the maturing deposits get renewed,” Mohan said.
”This, in turn, constrains an immediate substantial reduction in lending rates,” he said, at a conference in the London Business School.
Mohan said the reverse repo rate, at which the Reserve Bank of India absorbs surplus cash from the banking system, was the operational policy rate at present.
The rate now stands at 3.25%, a historical low, having been cut by 275 basis points in four moves since December.
In India, policy makers have relied on the central bank to prop up activity, as the government’s finances have deteriorated rapidly over the past year due to high subsidies, waiver of loans given to farmers and increase in salaries of civil servants and the downturn hitting revenues.
Unlike China, the size of fiscal stimulus packages announced so far have been small in relation to size of the economy, and Mohan said there was little scope to scale up spending.
”While the slowdown in the domestic economy may call for fiscal stimulus, fiscal manoeuverability is limited,” Mohan said.
In the 2008-09 fiscal year that ended on 31 March, the budget deficit widened to 6% of GDP, more than double the initial estimate.
The government estimates its total borrowing in the first six months of the fiscal year at Rs2.4 trillion ($48.1 billion), two thirds of its record full-year target for 2009-10.
In its policy review on Tuesday, the central bank said high government borrowing was working against the low interest rate environment it was trying to maintain
To stop the heavy borrowing pushing up bond yields and other money market rates, the central bank has said it would by buy back Rs800 billion of bonds in the first half of 2009-10.
Mohan said the open market operation calendar and amounts announced at the end of March were indicative, and the Reserve Bank could make changes if needed.
On Thursday, the central bank bought Rs60.5 billion of government bonds from the market at an auction, taking the total amount purchased this fiscal year to Rs120 billion.
Mohan said the central bank’s balance sheet was the ultimate source of money and credit creation and expansion in the economy.
”It is therefore important that the central bank balance sheet and the monetary base/reserve money continue to expand so as to meet the normal monetary requirements of a growing economy consistent with price stability,” he said.