Policy scenario pointing to return of administered rates?

Policy scenario pointing to return of administered rates?
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First Published: Wed, Dec 03 2008. 12 37 AM IST

No respite: The Reserve Bank of India headquarters in New Delhi. Bankers say despite policy signals, lending rates are bound to be sticky as banks have been raising term deposits rates recently. Harik
No respite: The Reserve Bank of India headquarters in New Delhi. Bankers say despite policy signals, lending rates are bound to be sticky as banks have been raising term deposits rates recently. Harik
Updated: Wed, Dec 03 2008. 12 37 AM IST
New Delhi: Is India headed back to an era of administered interest rates in banking? Some experts say recent events point to that direction, while others offer contrarian views.
Although the country’s banking regulator has cut its repo rate—the rate at which the Reserve Bank of India (RBI) lends to commercial banks—by 1.5 percentage points in the past few weeks, banks by and large have not lowered their lending rates in tandem, leading to the widest difference between policy and market lending rates in four years.
Bankers said despite policy signals, lending rates are bound to be sticky as term deposits rates have been increased recently.
No respite: The Reserve Bank of India headquarters in New Delhi. Bankers say despite policy signals, lending rates are bound to be sticky as banks have been raising term deposits rates recently. Harikrishna Katragadda / Mint
Besides the cost of term deposits, the divergence between policy and lending rates is also caused by the transmission mechanism of monetary policy weakening in the backdrop of financial turbulence, an economist said.
“The general phenomenon is monetary policy transmission becomes weak during turbulence. It is a global phenomenon,” said D.K. Joshi, director and principal economist at credit rating agency Crisil Ltd.
Between 1 August and 7 November, the lower end of the range of prime lending rate (PLR) of five major banks increased to 13.75% from 13.25%, according to RBI data. The upper end remained at 14%.
During the same period, the repo rate declined by 150 basis points to 7.50%. A basis point is one-hundredth of a percentage point. At the same time, the cash reserve ratio—the proportion of cash banks have to keep with RBI—was reduced by 350 basis points to 5.50%, lowering the cost of banks’ deposits. The regulator has also loosened prudential norms.
The widening difference has been interpreted as a symptom of policy going back a couple of decades by ignoring market reality and asking banks to toe a particular line in lending.
“The implication is that we are getting into an administered rate regime all over again. Interest rates are being artificially lowered and directed lending is taking place. This can get into a regime of financial repression,” said a head of a bank on condition of anonymity.
“Theoretically speaking, you are now distorting the price of capital in a capital-scarce economy and that too, at a time when it is in short supply,” the banker said, adding that lowering prudential norms was not entirely warranted.
To be sure, lending rates could soften shortly as public sector lender Punjab National Bank has reduced its PLR by 100 basis points and up to 100 basis points in deposit rates effective from 1 December. The bank’s PLR is now 12.50%.
However, Saumitra Chaudhuri, member of the Prime Minister’s economic advisory council, disagreed with the view that loosening prudential norms was not warranted.
The norms were tightened when an asset bubble was in the making and bringing norms in sync with falling assets prices only makes sense, he said.
Monetary policy has become the primary tool to combat an economic slowdown as the government has little room to introduce a fiscal stimulus package.
India’s fiscal deficit was budgeted to be 3% of the gross domestic product but home minister P. Chidambaram, who stepped down as finance minister on Sunday, recently said it would miss that target due to spending beyond the budget. “Fiscal policy acts faster than monetary policy. Monetary policy generally acts with a lag of 12 to 18 months,” Joshi pointed out. However, given the limited room to manoeuvre on the fiscal front, some loosening of banking norms is fine, he added.
A contrarian view was that looking at the divergence between policy and lending rates was like holding the wrong end of the stick.
Surjit S. Bhalla, chairman of asset management firm Oxus Investments Pvt. Ltd, said interest rates are the keys to tackle a slowdown and rates have not been lowered aggressively enough.
“Interest rates have to reflect reality and not government’s or central bank’s ideology,” Bhalla said. “My point is it (repo rate) should be 4%.”
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First Published: Wed, Dec 03 2008. 12 37 AM IST