In other words, the general burden that businesses and consumers bear is not coming down significantly enough to encourage the kind of investment and consumption that the central bank had hoped for. Worse still, bankers are cautioning they have very little headroom to cut lending rates in the near future, given their high cost of funds.
A look at the latest official data underscores why this is so. Loans by banks are growing at more than 14%, as investment activity gradually picks up. However, deposit growth is lagging, rising barely by 10%. This divergence has led to a shortage of funds, forcing banks to keep deposit rates high. Cutting them at this juncture would hurt deposit mobilization even more and make it tougher to meet the rising demand for loans. Further, now that interest rates on government saving schemes have been increased to keep the voters happy ahead of the general elections, and some new private banks are offering higher-than-market rates to attract customers, deposit rates are unlikely to fall. Banks say they cannot extend cheaper credit without their profits taking a hit.
To address a cash crunch in the overall economy as the fiscal year comes to a close on 31 March, RBI is now set to launch a rupee-for-dollar swap scheme worth $5 billion. This has widely been welcomed as a measure that will have an instant effect on fund availability. But for subsequent months, the overall credit flows of the banking sector need to ease. For this to happen, another RBI rate cut in April—even a sharper one than usual—of the rate at which banks borrow money from the central bank to meet their immediate needs, may prove inadequate.
With cuts in its repurchase rate proving to be a blunt tool, RBI may now need to intervene through some infrequently used policy options. One of them is the Cash Reserve Ratio (CRR), or the portion of deposits that banks must park with RBI for cash contingencies, even though they don’t get paid any interest on it. The CRR is currently at 4% and was last reduced six years ago. In addition, banks are required to hold 19.25% of their deposits as the Statutory Liquidity Ratio (SLR); this sum needs to be invested in safe assets such as government bonds and gold.
That takes the total funds unavailable for commercial loans to almost one-fourth of their total deposits. This is much higher than that in other major economies, and despite having come down over the past 25 years, it harks back to the days of India’s closed economy.
To be sure, in December, RBI did announce a phased reduction in SLR to 18% over several quarters. For a sustainable solution to the problem of too little money available for lending, policymakers should take an axe to the reserve requirements of banks. This is particularly important in the wake of a nascent investment recovery that needs a boost. A CRR or an SLR cut could do a better job of the task at hand.