Expert Zone
Straight from the Specialists
Cost of a rate cut delay in India
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The RBI took the first step to ease monetary policy by reducing CRR by 50 basis points on Jan. 24. However, it postponed an interest rate cut, in spite of the advice by the special committee, only to confirm its reputation of being cautious. But excessive caution can also cost the country a pretty penny.
Since then, there have been further developments. Liquidity in the system has been drying up and the RBI has been using open market operations to buy government securities in exchange for cash. That helped maintain the yield on long-term government securities within narrow limits though on short-term debt, like treasury bills, the government had to pay higher interest.
In recent weeks, inflation has climbed down from 9.1 pct in November to 6.7 pct in January. But while the RBI had been quick to raise interest rates with every point increase in inflation, it has been hesitant to cut rates in spite of easing inflation.
The obsession with high rates is causing growth to suffer. Last December, growth in industrial production was a mere 1.8 pct. That was mainly because of the 16 pct fall in capital goods production which reflects the sharp decline in national investment. In July-September 2011, for instance, national investment y-o-y was down from 30.3 pct of GDP to 28 pct. The main reason for holding back investment and income was the sharp increase in interest rates.
Interest rates rose to 8 pct in July 2011 from 5.75 pct in July 2010. Broadly, the rise of 225 basis points in interest rates caused national investment to shrink by 621 billion rupees in the July-Sept quarter of 2011 leading to a GDP loss of 1.03 trillion rupees.
The RBI has been careful to ensure that the interest rate for the government did not increase commensurately. Although the repo rate was up from 4.75 pct at the beginning of inflation to 8.5 pct now, the yield on 10-year government bonds moved in the range 8 – 8.5 pct. The RBI has been buying dollars or buying government securities to replenish liquidity. The full brunt of the rise in interest rates was borne by the private sector either by corporates on bank credit or by individuals on home or car loans.
RBI eyes deregulation of interest rate on savings accounts
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The RBI is keen to deregulate the interest rate on savings bank accounts and complete the marketisation of banking. But the banks which generally support deregulation insist that the RBI continue with control. What they are worried about is that deregulation would plug their cheapest source of funds.
Interest rates, whether on deposits or on credit, were deregulated as part of the reform process. Consequently, rates dropped dramatically and became a strong incentive for consumption, investment and growth. The only rate that is still governed by the RBI is the rate on savings deposits, apart from the policy rates like the repo rate or the bank rate.
The rate as also the method of calculation of interest payment on savings deposits had benefitted the banks unduly. It was only in April 2010, after about seven years of indifference, that the RBI gave some thought to the undue advantage the banks enjoyed with the low rate of interest and the wrong method of calculation. With the change, the savings deposit became more like short term lending by the depositor to the bank.
The interest on savings deposits is now calculated on daily basis on the outstanding amount. As such, the rate of interest on savings deposit must have some relationship with the interest short-term loans like treasury bill rate or call money rate like mibor.
In April last year, the rate of interest on savings account was raised from 3.5 to 4 percent. Since then it has been static while all other rates have zoomed up. In the last one year, the interest on 91 day treasury bills jumped 300 bps, repo market rate 200 bps and mibor 180 bps.
Obviously, with no change in the rate, savings deposits have become the cheapest source of funds which give banks the maximum spread. At the present base rate the spread is now 600 bps.
I think deregulation of interest rate can cause the unhealthy competation among the banks, most probably public sector banks suffer from this competation.
Signs of cooling in Indian economy
(The views expressed in this column are the author’s own and do not represent those of Reuters)
This was not unexpected. The RBI has taken every care to cool down the economy with successive increases in interest rates. The results are now beginning to show.
But ours is not the only economy that is slowing down. Almost every large economy is under pressure for one reason or the other and the IMF was consequently compelled to slice off its own estimate of world GDP growth by 20 bps.
Unemployment in the U.S. has climbed to 9.1 pct and Dow Jones sank for six consecutive weeks, the longest losing streak since 2002. The investor, however, expects the fall to be short lived in the hope that the Fed, which is too eager to pump in money, will intervene. Even that is not going to lift up the economy.
Growth continues to be weak in Europe. Spain is sinking deeper into the debt crisis. With the impact of tsunami, the Japanese GDP may drop 0.7 pct in 2011. The Chinese economy is cooling down after inflation at 5.5 pct and new loans down 12 pct.
It is no wonder that the Indian economy is also losing pace. The original sin is food inflation which, in spite of the costlier credit, persists. At the end of May it perked up to 9 pct.
GDP growth in the first quarter of 2011 slumped to 7.8 pct in spite of good agricultural production. It was industry that let growth down.
