We had argued in these columns on Tuesday that the time is not yet ripe for another cut in Indian interest rates. So, we welcome the Reserve Bank of India (RBI) governor Y.V. Reddy’s decision to leave all the major policy interest rates unchanged in the new monetary policy that was announced on Tuesday.
Bankers would do well to pay close attention to two warnings that are buried deep in the monetary policy announcement. They suggest that RBI expects banks to cut the interest rates they charge right away and also that it wants them try to address the credit problems of certain industries that are employment-intensive. (Perhaps RBI is talking about industries such as textiles that are reeling under the impact of a strong rupee.)
First, the macroeconomics: The Indian economy is clearly slowing. The most recent quarterly growth rate is 8.9% (for the second quarter of 2007-08), compared with 9.3% in the first quarter and 10.2% a year ago. But this is still above 8.5%, which we believe is the sustainable and non-inflationary rate of economic growth, given current rates of savings and investment. So, the mild slowdown is not a cause for worry.
RBI quite correctly points out that there are still aggregate demand pressures in the economy that could push up inflation. It adds: “…indications are getting stronger of upside inflationary risks in the period ahead.” Inflation, excluding food and fuel prices, could already be close to leaping out of RBI’s comfort zone. The bank also says that the drop in consumer price inflation could be a temporary phenomenon. Lower interest rates make little sense when the inflation dragon is stirring.
It is likely that the central bank will face a barrage of criticism from industry lobbies and large stock market investors for its caution. But those yearning for lower lending rates would do well to look closely at a stern warning to banks hidden at the very end of a typically long monetary policy statement: paragraph 99 in a 108-paragraph policy document.
RBI asks here why banks have not cut their deposit and lending rates despite ample liquidity in the financial system. These rates have been “broadly maintained at the elevated levels of the preceding year.” Bank profits and net interest margins continue to be at comfortably high levels. Bank credit growth has dropped despite all the liquidity sloshing around, as banks have preferred to park their money in various types of government bonds.
Is the central bank trying to pass the buck? Is it basically saying: We cannot cut interest rates as macromanagers of the economy, but your banker can definitely do so by settling for lower profits? Or is there a bankers’ cartel that is holding up the price of money?
It is hard to say for sure. Bankers tend to say that they have had to keep their rates high because they do not get interest on the cash balances they keep with RBI and also because they have been asked to keep extra capital in their books to back certain types of loans. So, they charge higher rates to customers to protect profits. Some analysts expect lending rates to drop in April, when many of the old high-cost bulk deposits contracted last year mature.
There is another thing that bankers should watch out for. RBI has said that banks may need to try to address problems in certain sectors. Monetary policy is fine for the aggregate economy, but not for sectoral troubles. “In view of the prevailing liquidity conditions and the sustained profitability of banks as reflected in net interest margins, there is a need for banks to undertake institutional and procedural changes for enhancing credit delivery to sectors that are employment-intensive,” says RBI.
We wonder: Is some fatwa around the corner, say, during the Budget?
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