In the current macroeconomic environment, any further reduction in policy rates would stoke inflation rather than push up growth.
June 19, 2012:
Kudos to the RBI for a bold mid-quarter monetary policy review, defying the expectations of the market and without yielding to the pressures of the Finance Minister to reduce the rates.
The Reserve Bank has taken a series of measures in the past few years to contain inflation and provide adequate credit for growth. But, unfortunately, neither growth nor price stability could be achieved to the desired extent.
The credit-deposit ratio has all along been above 70 per cent. However, industrial growth has not picked up. High interest rate was cited as one of the reasons for the slow growth, although the facts do not support this claim.
The economy suffered primarily because the Government did not take appropriate measures along with the Reserve Bank to boost the confidence of the investing community by, for instance, improving infrastructural facilities.
The taxation policies pursued by the Government have only added to the inflationary pressures and the Reserve Bank’s measures to contain inflation through dear money policy did not respond well enough for it to ease the policy rates.
Policy paralysis
The policy paralysis on reforms and administrative fronts on the part of the Government coupled with the adverse external factors added fuel to fire. The inflation rate has continued to be high due to both supply-side constraints and external factors. The negative sentiments and worsening fundamentals have led international agencies to lower the economy’s rating.
There, therefore, needs to be better coordination between fiscal and and monetary policies and the Government cannot slack up on containing the fiscal and current account deficit.
In the backdrop of weakening macroeconomic indicators, the decision of the Reserve Bank to keep unchanged the cash reserve ratioat 4.75% and the repo rate at 8 per cent needs to be appreciated and will only strengthen the economy in the long run.
Further, the reason given by the Reserve Bank for not effecting changes in the policy rates is logical. As per its assessment, there are several factors for the slowdown in economic activity, particularly investments, with the role of interest rates being very small. Consequently, any further reduction in the policy rate at this juncture would, rather than supporting growth, exacerbate inflationary pressures.
The liquidity situation in the market has improved. The deposits growth has been picking up. In case of any liquidity constraints, the RBI has open market operations to address the problem.
Banks must buck up
Banks have to do their homework by reducing their NIMs (net interest margins) and non-performing loans, particularly those coming under wilful default.
The recycling of funds has to improve and writing off of loans has to come down by improved supervision, follow-up and recoveries. They have to bring down the cost of funds by enhancing the CASA (current account, savings account) deposits and considerably reducing wholesale deposits mobilised at higher rates of interest.
To improve profitability, the cash-deposit ratio needs special attention. The overall asset-liability management if improved will help to bring down the cost of funds and pass on the benefit to borrowers by effecting reduction in the rate of interest. The banks can do their bit giving a helping hand to Reserve Bank in its effort to prop up the economy and put it back on a growth trajectory.
(The author is a Mumbai-based consultant. The views are personal.)
( This article appeared in Business Line dated 20/06/12).
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