The mid-term review: continuing the tradition

For all the eye catching headlines, the mid-term review is really a reiteration of RBI's caution on the interest rate front.

By C. R. L. Narasimhan

The mid-term review of the monetary and credit policy announced on October 22 surprised everybody in two distinct ways. The first has to do with the style. Under the present Governor, Dr. Bimal Jalan the RBI had over the past three years, made the bi-annual policy pronouncements ``non-events''. Which meant that headline grabbing news such as a variation in the bank rate /CRR. were noticeably absent even while the RBI took stock of the macro- economic situation, the ongoing financial sector reform and so on.

In its recent review too the RBI has devoted substantial time to the latter. Among other noteworthy points here: it has revised its forecast of GDP growth to between 5 and 6 per cent (earlier it was between 6 to 6.5 per cent).That the industrial sector has been dragging down the rate of economic growth has been another of its pertinent if obvious observation.

This time not only did the RBI act contrary to its form in announcing along with the mid-term review a reduction in the bank rate and in the CRR, it also surprised everyone by the extent of the CRR cuts. The bank rate has been lowered by half a point from 7 to 6.5 per cent, the CRR from 7.5 to 5.5 per cent. The two moves are complementary to each other as they work towards a softer interest rate regime. But over the short-term, the impact of the CRR reduction will be felt more. It will release Rs.8,000 crores for banks to lend. The key question here: will all those sums translate into loans for the corporate sector? Even if they do will they be at cheaper rates?

Looking at the recent banking statistics there is not much scope for optimism. During the first half of 2001-02 aggregate accommodation provided by banks to industry was Rs.23,737 crores and has been well below the corresponding figure for last year (Rs.38,114 crores). During the same period banks mobilised deposits at a faster pace (16 per cent) than last year (15.7 per cent).

The conclusion is inescapable: there has been no shortage of lendable resources. The system has already been flush with funds. The money released through the reduction of CRR will pose challenges to banks in deploying them. At another level, , the RBI will have to undertake open market operations (OMO) to suck out liquidity.

Credit delivery - the issue

There can be no doubt at all that credit delivery rather than credit availability that is the central issue. Mere funds availability do not and will not translate into funds for industry. Among the major factors inhibiting the growth of commercial bank lending to industry is the risk averseness that permeates decision makers at all levels of the banks' hierarchy. Equally relevantly in a financial sector whose contours are changing by the day due to the irreversible forces of disintermediation, bank loans to industry need not occupy the primacy they had enjoyed in the past. In other words, top rated borrowers can and will opt to go to the market directly instead of approaching banks and institutions to fund their working capital and term requirements.

In a recessionary economy, it can be argued, there is only little the banking sector can do to increase the credit offtake by industry. Since availability of credit has never be the limiting factor-at least over the past two years-the question that is to be asked is whether by lowering their lending rates banks will spur borrowings by industry. While that is the expectation of large and influential sections such as chambers of commerce and industry associations, available data point to no such connection.

Over the recent past along with the decline in the general level of interest rates, banks have also lowered their prime lending rates by a considerable margin. Yet credit utilisation by industry has not picked up.

Risk averse bankers have instead flocked to the security of government paper. Till October first week, banks have invested Rs. 43,664 crores in government securities, considerably more than the Rs. 25,636 crores for the same period last year. This year the Government will borrow more than what has been budgeted. (For the Centre alone gross borrowings have been budgeted at Rs. 1,18,852 crores). In fact fiscal profligacy of the government is a major deterrent to the flow of credit to industry. Ironically RBI has been among the first to voice concerns in that area.

Yet while its diagnosis has been on target always, it has -in the latest instance-gone much farther than what even the most ardent of the lobbyists would have asked for. However, by reading the mid-term review in greater detail one can see the RBI's imprint of caution all over.

Caveats and qualifications

Maintaining its resolve to maintain a stable interest rate regime, the RBI warns against taking a complacent view of the current monetary and interest rate environment.

There can be sharp changes in the interest rates even over the short-term. Moreover, there are rigidities in the system that prevent banks from lowering their interest rates further:(a)Banks are the primary mobilisers of financial savings.

Those who invest are generally the salaried class and other fixed income earners having an expectation of a reasonable nominal interest rate. In the recent past, the cuts announced in small savings schemes have not gone well with this class, who are beginning to articulate their viewpoint more effectively than ever before. (b) Majority of depositors have opted for fixed deposits. Interest rates so locked in cannot be easily varied except on their maturity.

(c) For public sector banks the average cost of funds is 7 per cent and for some private banks it is considerably more. The non- interest operating expenses generally work out to 2.5 and 3 per cent of total assets, putting pressure on the spread over cost of funds. (d) High level of non-performing assets (NPAs) and the large volume of government borrowing increase the upward bias in interest rates. (e) For all those reasons the link between the variation in the bank rate and the actual lending rates is not as strong in India as it is in the developed countries. (f) Meaningful progress on the interest rate front will come about only when structural rigidities are tackled.

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