The Hindu : Concerns over sustainability

Online edition of India's National Newspaper
Monday, May 05, 2003

Business

Business

Concerns over sustainability

Although most of the policy announcements were in line with market expectations, implementing them would be a real test for the banking system, says Oommen A. Ninan.

THE MONETARY and Credit Policy for the first half of 2003-04 has given a strong signal of a bias towards a soft interest rate regime, but it has also raised concerns over its sustainability in the longer run. Although most of the policy announcements were in line with market expectations, implementing them would be a real test for the banking system.

"The overall policy is along expected lines," said M. R. Ramesh, Managing Director, Clearing Corporation of India. The market had predicted a reduction in the Bank Rate and the Cash Reserve Ratio (CRR) by a small margin and the 0.25 per cent cut in both indicated a soft interest rate policy which also ensured adequate liquidity in the system to which the Reserve Bank is committed, he added.

However, there are enough indications in the policy announcement that interest rates have bottomed out and given the current inflationary conditions, any further downward movement of interest rates is not feasible. The policy points to the interest rate curve being almost flat at the longer-end. If there is no possibility of further reductions at the lower-end, the only way it could get corrected is by going up at the higher-end, Mr. Ramesh pointed out.

Rightly, the RBI Governor has indicated to banks the need for strengthening the investment fluctuations reserve to take care of any adverse movement in prices of securities, he felt. In the same context, the emphasis on banks going in for variable interest rates for deposits is welcomed from the point of view of managing interest rate mismatches between assets and liabilities.

Move on PLR welcomed

There is already substantial liquidity in the system and the CRR reduction may have only a marginal impact. Although there are moves by some banks to bring down the Prime Lending Rate (PLR), according to Mr. Ramesh, it is not clear if this can be sustained in the long run, given the inflationary expectations and the present interest rates, especially at the medium and long-end, which have bottomed out and can only go up. The statement that "in case demand pressures emerge and the inflationary situation worsens, which hopefully will not be the case, the present monetary policy stance may have to be reviewed" highlights this possibility. Incidentally, the proposed transparency in the fixing of the PLR by banks is welcome in that it will also be an indicator of the operational efficiency of banks.

"The present interest rates have no relevance at all for big borrowers as they are already getting funds at Mumbai Inter-Bank Offered Rate (MIBOR) or government of India securities (G-Sec) rates which are well below the PLR of any bank," said K. V. Krishnamurthy, Chairman and Managing Director, Bank of India. Moreover, the RBI has suggested a single PLR relevant to the cost of funds of the bank.

Though the cost of deposits and funds may not differ much from bank to bank, their cost of operations certainly vary. Further, the cost of holding and funding non-performing assets (NPAs) will also have make a substantial impact on the cost of resources for banks. Hence, banks with lower NPA levels may be in a position to offer lower lending rates than those having a larger portfolio of net NPAs.

Banks already functioning on thin margins may not be able to further reduce their lending rates substantially unless deposit rates too are brought down substantially. "Under these circumstances it may not be possible to expect big cuts in lending rates. Even the reduction in CRR will not have much impact unless there is an increase in credit offtake, which, unfortunately, is not happening at present," Mr. Krishnamurthy added.

Consequent to the RBI's policy announcement, India's premier bank, State Bank of India cut the interest rates by 25 basis points. "I perceive that spreads will now go down and the banking system has to focus on reducing transaction costs and improving productivity and efficiency," said A. K. Purwar, SBI Chairman. Another important factor according to him is the increased transparency being introduced in arriving at the PLR and this should be in the long-term interests of the banking system.

Further, Mr. Purwar felt that the policy would help push the system towards achieving global standards.

Money and govt. securities markets

With regard to the phasing-out of non-bank participation in the call money market, it has been stated that Stage II will be implemented from June 14.

Mr. Ramesh said it would have been better if a timetable had been given for further movement in this direction so that banks and non-banks could plan their operations. That would have also given a signal as regards RBI's intentions in initiating further action to strengthen the repo market.

Mention has been made of the Negotiated Dealing System (NDS) made operational for enabling on-line trading and dissemination of trade information relating to instruments in money, government securities and foreign exchange markets. But hardly any trade negotiation is taking place on the NDS screen.

It would be better if concrete steps are taken to see that it is being used by market players as a dealing platform for greater transparency and enhanced price discovery in the secondary market. As there is abundant liquidity in the system and primary dealers (PDs) have not been relying to any great extent on the normal facility, perhaps a further rationalisation between the `normal' and `back-stop' facility could have been attempted.

Looking at the long list of legislative proposals under consideration of the Central Government detailed under the annexes to the Monetary and Credit Policy, Mr. Ramesh concluded that "one can't help feeling that one will have to wait for some time for all the required reforms in the financial market to take place".

Printer friendly page
Send this article to Friends by E-Mail

Business

Stories in this Section

Concerns over sustainability

Revamp puts Indian Bank on steady road

RBI against uni-directional perceptions on rupee

Bank stocks steal limelight

Technology development, credibility and economics

Centre keen on single law for SSIs