Liquidity, inflation and economic growth

The mid- term review of monetary policy by the Reserve Bank has not brought out any drastic changes to contain inflation perhaps keeping in view the need to support the economic growth envisaged at around 9 percent and the moderated level of inflation although it continues to remain in the uncomfortable zone. The problem of liquidity of banks is well recognized and the measures introduced to come to banks’ rescue include reduction of Statutory Liquidity Ratio of Scheduled Commercial Banks from 25 percent of their Net Demand and Time Liabilities to 24 percent with effect from December 18,2010 and conduct of open market operation auctions for purchase of Government securities for an aggregate amount of Rs 48,000 crores in the next one month. These measures at best may improve the cash crunch position of banks but cannot improve their liquidity position on an endurable basis.
The present liquidity shortage with the banks is very tricky. Disinvestments by the Government have taken away the deposits of the banks. The advance payment of taxes by the corporate and high net worth individuals also has affected the deposits of banks. The negative rate of return on deposit interest rate because of high level of inflation persisting for quite some time seems to have prompted investors to divert their deposits from banks to other forms of assets such as post office savings, real estate, gold and other commodities.
The funds of Government lying with the Reserve bank at around Rs 85000 crores without earning any income and the borrowings of the Government at a cost from the Reserve bank do not seem to be good funds management and the adverse effect is on the economy. The utilization of the surpluses will ease the liquidity to a great extent. In this context, the measure announced by the Reserve Bank to reduce the Statutory Liquidity Ratio by one percentage point to 24 percent on a permanent basis is a well thought out plan and helps banks to widen their commercial credit instead of locking the funds in Government and other approved securities. To this extent the preemption of bank deposits for the Government Securities goes and the banks can have an improved funds management.
The Cash Reserve Ratio is kept unchanged at 6 percent. Banks can derive the full benefit only if they improve their deposits substantially. The banks’ loss of income on these Reserves and additional expenditure that they have to incur on their borrowings from the Reserve Bank under REPO at 6.25 percent affect not only their liquidity but also their profitability. The only way to come out of this situation is to considerably enhance their deposit base for which banks have to work hard and find innovative ways. The Reserve Bank’s Governor’s call to banks made during the Bank Economists’ conference held recently in Mumbai to enhance deposit interest rate and reduce the interest rate on loans assumes significance and needs to be seriously pursued. The NIM needs to be brought down and the volume of business turnover has to be augmented to improve the profits. Both balance sheet and off balance sheet size have to increase with an eye on improved earnings not counting much on NIM.
Some of the ways to enhance banks’ business turn over would be to seriously step up financial inclusion, tie up their business with tourist operators in the context of increased interests visible in national and international tourism, taking advantage of investors new found interest in commodity market particularly gold and derivative trading in foreign currencies and encouraging transactions through banks and banking instruments like cheques, demand drafts, plastic cards, mobile and internet banking. The public preference for cash needs to be drastically curbed to improve the bank deposits. Management of advances portfolio keeping the non performing and the potential non performing advances as low as possible by avoiding aggressive and speculative lending will also help the banks to improve their liquidity and profitability.
The high level of inflation continues to be a cause of concern and there are no signs of it coming down. The increase in oil prices both in domestic and international markets, continued high prices of food items despite a favorable monsoon season, the ever raising trend observed in the manufacturing cost due to increased cost of materials , transportation charges, and cost of funds in general and bank loans in particular etc pose a challenge and to what extent monetary policy alone can contain the inflationary trend is a matter to be seriously pondered? Continuance of inflation at a high level for a long time can harm the economy in the long run and the fact that inflation is the number one enemy of public cannot be ignored or forgotten. Economic Growth should bring in benefits to the masses who need food, cloth and shelter. If these essentials cannot be provided, there is no point in having any policy and the economy should not be proud of its growth.

T.V.Gopalakrishnan

National Gold Bank

This refers to the article on "India's fetish for gold( ET Dt, 20 th Dec2010).It is well known that India has a weakness for Gold and it is unlikely to have a shift away from gold into financial savings.The crux of the matter is that investments in gold is unproductive as the economy is concerned. The economy has high growth aspirations and there is urgent need to develop the infrastructure to support the growth.It would be worthwhile to think of establishing a National Gold Bank taking advantage of huge holdings of gold and with the backing of gold money can be raised to finance the infrastructure. There can also be a regulated way of investments in gold and subsequent dealings in gold if there is such a bank.


T.V,Gopalakrishnan

( This appeared in ET dated 24 th December 2010)

Monetary Policy : More needs to be done

Monetary policy: More needs to be done

The monetary policy announced by the Reserve Bank for the second quarter is on expected lines.
In the context of a mixed backdrop of persistent sluggishness in advanced economies, positive signals of growth in developing economies, continued inflationary pressures in domestic economy and the need to maintain the trajectory of GDP growth in the region of nine per cent, the Reserve Bank has very limited choice to venture into any dynamic policies although the inflows of foreign exchange continue to disturb the exports, exchange rate, current account deficit, money supply, inflation, liquidity and interest rate and demand a separate treatment.
Growth of economy
Earlier, measures and professional approach of the Reserve Bank have paid off very well in ensuring steady growth of the economy at around 8.5 per cent. It may even cross nine per cent by March 2011 provided industrial, export and import growth maintain the present trend.
Even agricultural production can be better in view of the favourable monsoon this year. The non-food credit pick-up has been on the projected lines at around 20 per cent and would continue to persist/improve further.
consumer confidence index
The consumer confidence index has placed India in a strong position (India's index points 129 for the April – June quarter) and this should help the industry, particularly consumer durable industry, to perform well. The money supply has been well contained within the projected level and at the same time, by and large, adequate liquidity has been maintained in the economy. Base rate system, replacing BPLR introduced with effect from July 1, has more or less stabilised indicating effective transmission of the Reserve Bank's measure in the credit market.
RBI steps to curb inflation
However, the concern of the Reserve Bank to contain inflation continues and the measures announced in the present review are well aimed at bringing down the inflation to around 5.5 per cent. But, unfortunately, inflation control in the economy is dependent on several factors which inter-alia include the inflows of foreign exchange on which the Reserve Bank has only limited control.
The quantitative easing in advanced economies has of late been unpredictable and the interest rate scenario in international market has reached its lowest ebb forcing investors to look for greener pastures in developing economies and India is a better destination due to its political and economic stability.
The flow is more on account of international economic scenario and unless and until the advanced economies recover and their interest rates tend to be attractive, the inflows will continue to be there.
Although the funds are welcome, the speculative nature of inflows can destabilise our system and needs to be tackled with some innovative measures.
The need to counter FIIs' dominance over the domestic capital market is the need of the hour and the present policy review has not come out with any measures to prevent undesirable inflows. Inflation being caused on account of such inflows in particular is somewhat difficult to contain as the normal approach of intervention in forex market and resorting to sterilisation measures have their own limitations and cost to the economy.
This dilemma of the Reserve Bank is a reality in the present scenario of domestic and international economic situation.
The financial position of the Government has improved considerably and this should give the Reserve Bank lots of comfort.
The fiscal deficit will be well within the budget estimate in the context of large spectrum auction realisation, improved tax revenues, significant inflows from disinvestment and reduced market borrowings.
Repo rates hike
The increase in repo and reverse repos rate by 25 basis points each will make the funds costlier i.e., only to check inflation growth but not to affect economic growth adversely.
The fact that the cash reserve ratio has not been touched will ensure continued availability of reasonable liquidity.
However, the deposit growth, which continues to lag behind, will have its own consequences on banks' funds position and needs to be tackled.
Deposit growth
The Reserve Bank's observation that the real rate of interest continues to be negative despite hike in deposit rates on account of high inflation and diversion of deposits seeking higher rate of return from alternative investments in gold, real estate, stock market etc. takes place needs to be seriously viewed and action initiated to arrest this trend.
The stake is very high for the economy as there is already a boom in real estate, gold and stock market prices. The abnormal increase in prices in these assets should not be construed to mean by any means the strength of the economy.
This has been adequately cautioned by the Reserve Bank and some measures in the housing loan segment have been proposed.
The prices should really reflect the fundamentals of the economy, purchasing power of the large segment of the population and the demand and supply of assets. The monetary policy of the Reserve Bank alone cannot be a panacea for the problems the economy faces.
Dr.T.V.gopalakrishnan

(This appeared in Business Line dt 8/11/10)

Failure of regulation

This refers to your edit Banks should not be forced to lend to MFIs (ET dt 30/10/10). Micro Finance Institutions are in the news for the past few days for all wrong reasons. The MFIs emerged on the model of Grameena Banks in Bangla Desh as a panacea to remove the poverty levels among the poor in agricultural and rural sector through provision of small loans without requiring collaterals, have of late been a cause of concern for the authorities. They were allowed to grow and function without much of regulatory and supervisory controls and they had grown very fast exploiting the weaknesses in the credit delivery system particularly under rural segment.
The failure of banking system to make financial inclusion a reality and the inclusion of loans by banks to MFIs as a priority sector advances became very handy for MFIs to lay strong foundation in rural areas. In the garb of an institution and with the indirect encouragements they received as Non Banking Financial Companies they took the role of informal money lenders and could entice the poor with their initial concessions and incentives. Some of the new generation banks in particular found it convenient to expand their exposure to agriculture and village industries through MFIs and for the latter the funds they got from banks became a source to spread their business only to exploit the poor. The crux of the issue is financial exclusion and failure of authorities to come out with proper regulation and supervision of MFIs at appropriate time. As rightly pointed out in your edit, the solution to control MFIs is to make the financial inclusion compulsory with the aid of technology, mobile phones and UID.
Dr T.V.Gopalakrishnan

( An edited version of this appeared in Economic Times Dt 2/11/10)

Banks put up good show during the global financial crisis

Banks in India put up good show during the global financial crisis:

The performance of various bank groups as on March 2009 and March 2010 had been impressive despite constraints faced by them due to slow down in the economy because of global financial crisis and adverse real economic scenario witnessed all over the whole world. A few selected parameters indicating Bank Group-wise Performance as at end March 2009 & 2010 is furnished below.

(Fig in per centage)
Bank Groups Cost of fund Return on adva Return on Net NPAs
adj to cost assets
of funds


2009 2010 2009 2010 2009 2010 2009 2010
SBI & Subsidiaries 5.94 5.32 3.95 3.60 1.02 0.91 1.47 1.50
Nationalised Banks 6.09 5.35 4.09 3.83 1.03 1.00 0.68 0.91
Old Private Sector Bks 6.67 6.13 5.15 4.81 1.15 0.95 0.90 0.83
New Private Sector Bks 6.06 4.43 5.23 5.13 1.12 1.38 1.40 1.09
Foreign Banks 4.46 2.82 8.14 7.17 1.99 1.26 1.81 1.82
All Sch.Commercial Bks 5.96 5.09 4.53 4.19 1.13 1.05 1.05 1.12
Source: Reserve Bank of India- A profile of banks 2009-10.


Performance Parameters during the two year period showed that banking sector exhibited its remarkable resilience in withstanding the impact of global economic crisis. Increase in Net NPAs or fall in return on assets during the period was marginal whereas the cost of funds registered a significant decline. Analysis of bank group-wise performance was as follows.
Cost of funds:
The cost of funds had come down considerably during the year 2009-10 although it continued to be high for all bank groups except for foreign banks. While the cost of funds which ranged between 4.46 per cent and 6.67 per cent for different bank groups in March 2009 came down considerably and worked out between 2.82 per cent and 6.13 per cent in March 2010. Foreign banks could bring down their cost of funds from 4.46per cent to 2.82 per cent during the period, whereas the state bank group and nationalized banks could bring down their cost only from 5.94 per cent to 5.32 per cent and 6.09 per cent to 5.35 per cent respectively. While the new private sector banks could bring down their cost of funds sharply by 1.63 per cent, the old private sector banks could bring down their cost of funds only by 0.54 per cent during the period. Cost of funds for public sector banks and old private sector banks continued to remain high and is a matter of concern. The reasons perhaps for their high cost of funds could be due to high overhead costs because of comparatively low penetration of computerization, information technology, high wages of their human resources as they are comparatively in the higher age profile and relatively higher rate of interest offered on deposits and high cost of deposits. The cost of funds in general and interest rate on advances in particular have to be necessarily brought down to remain competitive in business and improve the credit portfolio.
Return on advances adjusted to cost of funds:
Return on advances adjusted to cost of funds in respect of various bank groups remained in the range of 3.95 per cent and 8.14 per cent as at end Mach 2009 and 3.60 per cent and 7.17 per cent as at end March 2010. Among various bank groups State Bank Group had the lowest return on advances for both the years March 2009 and March 2010. Foreign banks outperformed the entire bank groups as their return on advances adjusted to cost of funds stood at 8.14 per cent and 7.17 per cent as at end March 2009 and 2010 respectively. The new private sector banks also did well as compared to all other bank groups with 5.23 per cent and 5.13 per cent during the two years. Sustenance of this sort of return will be a major task for all bank groups in a dynamic financial market.
Return on assets:
In respect of return on assets, while the foreign bank group scored well as compared to the other bank groups, state bank group stood lowest even compared with old private sector banks. It is noteworthy to observe that while the new private sector banks increased their return on assets from 1.12 per cent in March 2009 to 1.38 per cent in March 2010, all other bank groups including foreign banks registered a decline on their return on assets during the period.
Net NPAs:
Barring state bank group, nationalized banks, and foreign banks, the other bank groups could show a reduction in their Net NPAs during the period 2009 -10. The benefit of restructuring of assets might have come to the rescue of banks to improve their NPAs position.
Analyses of different parameters indicate that foreign banks displayed comparatively a better show and there is scope for public sector banks and old private sector banks to better their performance. The economy is doing well except perhaps on inflationary front and the time augurs well for the banks to widen their business further taking advantage of the gaps in the area of financial inclusion, infrastructure funding and financing of agriculture and related industries.
T.V.Gopalakrishnan
(This appeared in Business Line dt25/10/10

Bank Deposits and Risk Perception of Depositors

Bank deposits and risk perception of depositors

As banks have risk assessment for deploying their resources, depositors have their own perception of risk about banks for depositing their savings and to that extent the financial literacy can be considered to be very high and the awareness about market risk is appreciable. This is evident from the position of deposits of various bank groups in India during the period 2008- 2010 ie the beginning of crisis during the crisis and afterwards. The global financial crisis which triggered in September 2008 in US market and subsequently spread all over the world has impacted the Indian banking in several ways although it remained insulated from the severe jolt experienced by its counterparts particularly in advanced countries. The bank group wise figures illustrates that the confidence level of public in private sector banks including foreign banks has witnessed a set back and it has increased considerably in public sector banks during the crisis period. Depositors seem to have perceived more risk in depositing their money with private sector banks and shifted their loyalty to public sector banks as revealed by the figures.

Public confidence in banks depends basically on ownership, sound regulatory and supervisory system in force and insurance coverage for their deposits. They also worry about the inflation risk and they have their calculation on real interest and hedge against this risk. As the insurance coverage for deposits is limited to only Rs 1 lakh per depositor irrespective of the bank (whether private or public) in which the deposit is made, the preference of public for safety of their entire deposits with public sector banks is understandable and is fully justifiable during a crisis period like the one the world experienced since September 2008. Although the Indian banks are well run and financially sound because of efficient and effective regulatory and supervisory mechanism, the preference for public sector by depositors is apparent and well exhibited as revealed by various parameters. For instance, the share of public sector banks in total deposits which stood at 73.91 percent before the crisis ie as at end March 2008, increased to77.61percent as at end March 2009 ie during the crisis and further to 77.68 percent as at end March 2010 after recovery began. The following table will indicate share of deposits to total deposits and rate of growth of deposits in different bank Groups during 2008-10.

Bank groups 2007-08 2008-09 2009-10
Share of deposits to Total deposits Rate of growth of deposits Share of deposits to Total deposits Rate of growth of deposits Share of deposits to Total deposits Rate of growth of deposits
Public Sector Banks 73.91% 23.05% 76.61% 26.85% 77.68% 18.60%
Old Private Sector Banks 4.99% 19.78% 4.90% 20.34% 4.84% 15.37%
New Private Banks 15.34% 23.13% 13.22% 5.43% 12.48% 10.39%
Foreign Banks 5.76% 26.81% 5.27% 11.99% 5.00% 11.11%

The rate of growth of deposits in general has registered a sharp decline in all bank groups as at end March 2010 as compare to that of end march 2008 perhaps evidencing increased awareness among public to hedge against inflation. While the inflation rate has been on the increase for the past couple of years, the rate of interest has fallen leaving no incentive to save money with the banks. High inflation adversely affects the capacity and propensity to save. In the absence of any real rate of interest, the public seem to have opted to spend more, save less and invest available surplus in alternative assets or instruments such as gold, real estate and other instruments of savings which fetch offer better return than banks. The increase in real estate, commodity prices (particularly gold and silver) and sensex which has recently crossed 20K is a clear indication that public awareness about investment market has gone up and their risk perception, risk assessment and risk management have improved well .

While the share of old private sector banks and foreign banks in total deposits showed a marginal decline during the period 2008 -10, the share of new private sector banks declined considerably from 15.34 percent in 2008 to 12.48 percent in 2010. The rate of fall in deposit during the crisis year ie 2009 is significant in new private sector and foreign banks as compared to other bank groups.

While the investors awareness about market risks and alternative avenues of investments is welcome, the risks they carry on speculative investments in gold and real estates are something of very high order. The markets and the economy also carry heavy risk from this sort of build- up of assets in the long run and need to be taken care of.

Dr.T.V.Gopalakrishnan

(This appeared in Business Line dt4/10/2010)

sensex,Real Economy and the reality

Sensex, Real economy, and the reality

This refers to your edit 'The Sensex Rides again' (ET,dt 22nd Sep,2010). The sensex has again crossed 20 K mark after a gap of 32 months and the market men are happy. Even the Finance minister has expressed his happiness by saying that after 2008 January, for the first time it has crossed 20,000. No doubt, it signifies the improvement in the confidence level among investors both from domestic and international market over the fact that the economy is performing well and will continue to perform better in future also. But, how far, this confidence is sustainable and manageable is an issue well analysed in your edit.

The rise in index is basically on account of increased flow of funds from international markets seeking better return. The investment climate in both the US and European markets is not very conducive both in terms risk and return and the investors have found better avenues to divert funds to Indian market which is safe and offer higher rate of return. From Foreign institutional investors angle, it is fine, but to what extent our economy can absorb these funds without being hurt is what needs to be examined when the index goes up and up. The real economy is not that bright as on today with low productivity in agriculture, high unemployment, high inflation, inadequate infrastructure,high level of poverty etc etc to boast of a high sensex index which in any case cannot be a yard stick to measure the real strengh of a developing economy.

The inflows of short term funds seeking quick returns purely on a speculative basis although essential perhaps to provide liquidity and strength for capital formation and capital market, bring with them the problem of exchange rate and interest rate management which have a bearing on exports, imports, inflation, current account deficit etc.This has to be kept in mind while assessing the benefits of rise in sensex. Capital market is germane to a large segment of population is a fact in India and cannot be ignored . In fact an index indicating how much of the population is part of the capital market would be a better yard stick to assess the strength of the real economy.

Dr.T.V.Gopalakrishnan