Bank Rate reduction: full impact will be felt after some time

CHENNAI, APRIL 2. On Saturday the Reserve Bank of India announced a one per cent across the board cut in the Bank Rate, the CRR (cash reserve ratio) and the repo rate. All these come into effect on or after April 1, 2000.

The timing of the announcement has obviously plenty of significance. Banks and financial institutions, who will be preparing their financial statements for 1999-2000, cannot claim any appreciation on their investments in Government securities which a lower interest rate regime will automatically cause.

They would in that case have claimed superlative financial performance, not warranted by their actual functioning during the year.

A Bank Rate variation is the most traditional signalling device used by the Central banks to bring about changes in the interest rate structure. For a long time the bank rate mechanism was kept in hibernation in India: in an administered interest rates regime of the type prevalent here there was no reason to use a signalling device.

What will happen

When financial sector reform gathered pace during the last decade, most of the controls over the interest rates were removed. Therefore beginning January 1998 the RBI has chosen to rely on the bank rate once again.

From 11 per cent at that time it has been gradually brought down to 10.5 per cent on March 19 1998, 10 per cent on April 3,1998, 9 per cent on April 29, 1998, 8 per cent on March 2,1999 and to the latest level of 7 per cent.

What will be the consequences? A powerful signal though it is, a Bank Rate cut by itself may not be able to achieve the desired result (of interest rate softening). So few interest rates are directly ``attached'' to the Bank Rate.

On Saturday the RBI announced that simultaneous to the Bank Rate reduction, the other facilities that will attract lower rates are export credit refinance, collateralised and additional collateralised lending facility, liquidity support to primary dealers, advances to state financial corporations and ways and means advances and overdraft to the Government of India and State Governments.

As for the other interest rates - both lending and borrowing - one can only share the RBI Governor, Dr. Jalan's view that the individual banks and institutions will take some action soon. Committees comprising of senior officials of banks will decide on the interest rate cuts. Most of them would be meeting from early this week onwards. So while a full picture might emerge in a few days time it looks improbable even at this stage that there will be a sharp drop in the lending rates of banks. The betting is that the lowering will not be by more than a half to one percent.

There are very valid reasons as to why the banks cannot lower their rates any further: the Indian financial system is saddled with costly liabilities (deposits) assumed in the past whose effect will continue for some more time; there is no variable interest mechanism yet: unlike in say the Euro dollar market, banks in India do not match a specific lending with a specific borrowing; there is still a large measure of relationship banking.

Customers do not always rush towards cheaper loans as they keep their larger banking interests in view. Besides, the financial health of the financial sector is at stake. Public sector banks especially saddled with huge operating costs will have to operate at a certain spread (the difference between the interest paid and interest charged).

Already with their margins squeezed and with competition both from within the banking system and from outside intensifying, the health of the financial system has been a matter of utmost concern to the Government. Very soon it will occupy centre stage, along with the major economic worries such as the burgeoning and seemingly intractable fiscal deficit.

It is puerile to think that the industry lobbyists who for ever clamour for cheaper credit will have the problems of the financial sector in their view. Interestingly the RBI has brought about the last reductions less than a month before its scheduled annual credit policy announcement. It is certain that the timing has as much to take the winds out of the clamour for rate reductions as it is to demystify the process of credit policy formulation.

At another level, a RBI study has conclusively proved that credit disbursements are not necessarily a function of lower interest rates. It is well known that there are other obstacles to credit delivery, which an even higher figure under non-food credit (as for last fiscal) cannot hide any longer. What seems likely for now is that in conjunction with the cuts in the CRR and in the repo rates, the bank rate reduction will signal an easier though not necessarily a substantially cheaper credit regime. The CRR cut is part of the reform measures of doing away with statutory pre-emptions. In the recent past the RBI has not hesitated to increase the CRR percentages.

The one percent reduction (to be effective in two stages) will release Rs.7,200 crores. This measure is intended to facilitate the government borrowing programme of Rs.117,000 crores scheduled to start soon.

The larger issue as to whether the RBI intended to generate a feel good factor shall remain unanswered for now. That is because pragmatic as the RBI's recent monetary policy stance has been it has been consistent in upholding certain core functions.

It was while fighting the foreign exchange speculators that the RBI changed course and raised CRR in august 1998. A greater elucidation of the economic goals will surely come at the next major occasion - the credit and monetary policy statement at the end of this month.

CRL

Send this article to Friends by E-Mail

Section  : Business
Previous : Economy stocks gaining momentum on bourses
Next     : PSE disinvestment: the obstacles remain