A Cautious Approach

Updated: Nov 4 2003, 05:30am hrs
Dr YV Reddy, in his first credit policy announcement, has adopted a cautious approach towards interest rate reductions. There were high market expectations of a 25-50 basis points (bps) bank rate cut. This may have disappointed the industry but certainly provided reprieve to the large constituency of individual savers. Over the last 24-30 months, the RBI has responded to industry by reducing interest by over 500 bps, which has been a substantial reduction. However, there continues to be excess liquidity in the system with no corresponding credit offtake. Successive reductions of bank rate are not the only a tool for economic growth. A balance has to be maintained between providing incentive for savings to the large Indian middle class and cheaper credit to industry and retail lending.

Given the optimistic outlook of GDP growth exceeding 6.5 per cent, strong resurgence in stock markets, benign inflation and strong forex inflows there is no pressing need for further reduction in interest rates. Under such circumstances it is prudent for the RBI to take stock of the situation before announcing further rate cuts. It is likely that RBI may re-assess its position on the results of strong projected agricultural and industrial growth. Another important consideration, while determining interest rates, is the presence of administered rates on small savings instruments. These rates are considerably higher than rates offered by the banking system and can result in a change in the composition of household savings.

Burgeoning liabilities on account of government pensions and administered rates are a huge strain on fiscal balance. The Governor, in his statement, has indicated that prime corporates and retail borrowers have been the prime beneficiaries of low interest rates. There are large sections of borrowers which have not benefited from the low interest rate regime. There is a need for banks to closely review their lending norms and delivery mechanisms to address this anomaly. The setting up of a committee to monitor systemically important financial intermediaries (SIFIs), including participation from Irda, is an important development. This Policy is a stock-taking one, which, while maintaining a soft interest rate bias, emphasises the need to assess the results of monetary measures taken in the last two years.

The author is Country Head & CEO, AIG, India