RBI Watch Monetary Policy 2014-15
Banks can reduce their lending rates without waiting for the RBI to reduce its repo rate
Banks can reduce their lending rates without waiting for the RBI to reduce its repo rate
Yesterday the Economic Times reported that the Finance
Minister pinned the blame for the slump in manufacturing on high interest rates.
The ET’s interpretation of this was that FM wanted the RBI to reduce its key
rate, the repo rate. Today, the ET reports that FM criticised reports that he
has differences with Governor Rajan on interest rates.
Whatever the full facts, there is clearly some truth in yesterday's report: the government would love to see bank lending rates lower, and if the
RBI could accomplish this by reducing its key repo rate so much the better.
The fact is that banks have sufficient liquidity, and they do not need the RBI to
lower its repo rate to reduce their lending rates. Note also banks have
greater capacity to lend now – remember the reduction in Statutory Liquidity
Ratio, the amount banks must compulsorily invest in government securities, by
RBI in its earlier policy statements this fiscal year. One could expect banks then
to lend more by reducing the lending rate. But this has not happened, perhaps
because banks want to increase their profit margins after some years of stress
on assets. Note, some banks have reduced deposit rates.
There is also another factor that could be playing on the
mind of banks: the expected hike in interest rates by the Federal Reserve next
year. The market’s expectation is that it will not happen before April next
year. A rise in interest rates in the USA will certainly put pressure on India:
a withdrawal of liquidity from India is possible but could be countered with
macro reform measures -the government is acting on this front with energy through
ordinances - and tactical micro market measures.
On the RBI’s part, as
I have said earlier, it wants to send a strong signal that
it wants to keep real interest rates positive at the 1.5 to 2% level on a
sustained basis. This is the new monetary policy paradigm
under Governor Rajan and his team. High inflation in India was supported by
negative real interest rates.
Inflation (CPI ) has trended down at a faster pace than the
RBI expected – for three months now it has
been below the 6% target set by the RBI for Jan 2016. The fact of the matter is
that weak demand in India has played a part in this. So has the exceptional
deflationary situation in the developed world, and even in China, where for 33
months there has been PPI deflation, and the latest CPI came in at 1.4%. And to top it all, we have a deflationary oil price shock!
The RBI expects, after the base effects wear to off in
another month or so, to see an uptick in inflation. Its estimate is that inflation
will be around the 6% level by January 2016. So, a repo rate of 8% - a real
rate of about 2% - is consistent with this scenario. My sense is that if the
uptick is less than what the RBI expects – I won’t be surprised if this happens
- then you will see a small reduction in the repo to 7.5%.
Just as in the case of banks, RBI is worried about the hike
in interest rates in the USA next year. Ideally
it would like to see through smoothly the first phase of the hike in fed funds
by the Federal Reserve before reducing the repo rate.
The bottom line is that the RBI, left it itself, is in no
hurry to reduce its repo rate. This makes good sense.
Finally, both the government and the RBI are by and large on the same page
when it comes to growth of the economy. The Government is looking at the immediate picture - shall we say just as
the CEO of a company is answerable for quarterly profits to shareholders - as well as the
long run. The RBI seems more focused on the long run.
This is what Rajan said on growth in his press conference
after the release of bimonthly monetary policy statement statement on December
2:
“On the first, I think there is a misconception in corporate
India that the central bank is not concerned about growth. It is a
misconception because the fundamental way to get sustainable growth in this
country, and we are not talking about growth this quarter, in fact, monetary
policy will not affect growth this quarter, it has long lags, it has been
established in India, 3-4 quarters down the line we will see the consequence. What again and again we have seen is in
India but outside India also the way to sustainable growth is to have moderate
inflation.”
