Reserve Bank of India (RBI) governor D. Subbarao could have gone in for yet another do-nothing policy on the lines of two previous announcements he had made since he came to the central bank. Not too many bankers and bond dealers would have found fault with him, as at least half of them were not expecting any cut in policy rates.
Yet, Subbarao has cut both the policy rates—the repo rate at which RBI infuses liquidity in the system, and the reverse repo rate at which it sucks out liquidity by buying overnight money from banks—by 25 basis points each. The repo rate is now 4.75% and reverse repo rate 3.25%.
One way of interpreting his action is buying an insurance cover against an uncertain outlook. The governor is anxious that the worst is not behind us yet. Nobody knows the exact quantum of tainted assets globally. It’s also not clear whether the deleveraging process is complete. And, finally, whether the measures taken so far are enough to bring the economy back on the growth path.
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Subbarao could have waited for the new government to come in and the Union Budget for fiscal 2010 to be passed before taking his call as that would have given him a clear idea about the contour of the government’s borrowing programme. But he has decided against doing nothing.
The act also demonstrates that he is fast losing his patience with India’s commercial bankers who are refusing to bring down the cost of money for their borrowers. Before the latest round of rate cut, RBI had cut the repo rate by 400 basis points and the reverse repo by 250 basis points. Besides, banks’ cash reserve ratio or the portion of deposits that banks need to keep with RBI has also been cut 400 basis points, releasing Rs1.6 trillion in the system.
But the average prime lending rate, or PLR, of public sector banks has fallen by 125-225 basis points, private banks by 100-125 basis points and foreign banks by just 100 basis points since October. There has hardly been any drop in rates of unsecured loans and mortgages. PLR is the rate at which banks are expected to offer loan to their most credit worthy borrowers.
Even though policy rates have been at historic lows, banks’ lending and deposit rates continue to be higher than what they were five years ago. Indeed, banks have their own excuses such as high interest rates of small savings schemes run by the government. Since most of these offer 8% interest, banks don’t want to bring down deposits rates below 8% for fear of losing money to such schemes. And, as they cannot bring down the deposit rates, the loan rates, too, remain high. This is because any shrinkage in the net interest rate margin, or the difference between the cost of deposits and earnings on loans, affects a bank’s profitability.
But Subbarao doesn’t seem to be willing to listen to these excuses. The reverse repo rate has been brought down to discourage risk-averse banks from parking excess liquidity with RBI. Instead of earning risk-free 3.25% by keeping idle money with RBI, banks must lend to corporations and individual borrowers and buy bonds. This also sends a clear signal to the banking community that when moral suasion fails, there are other tools to bring down rates. Banks will now have no choice but to pare loan and deposit rates. RBI will probably go for another round in its quarterly policy in July to give the final push to growth and tell banks that they should not take the regulator for granted.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Please email comments to firstname.lastname@example.org