The last 12 months haven?t been easy for any central bank across the world. Although the worst may have been over for India, which was relatively insulated from the turmoil in the western economies and whose large home market fuelled a resurgence in demand, it?s not that RBI has had it easy. Looking back, RBI did a good job of first ensuring that the growth revived after the downturn post-Lehman; a series of rate cuts and freeing up of liquidity allowed both companies and individuals to borrow at reasonable rates. However, many would say RBI left it a little too late where inflation was concerned, although that can be debated since much of the inflation had to do with supply-side pressures. Unlike demand shocks, supply shocks have asymmetric implications for inflation and growth.
Nevertheless, the 100 bps increase in key policy rates, since the start of the year, or the calibrated exit from an accommodative monetary policy stance, seems to be working well and given the good monsoon, inflation should taper off by March next year. There have been no complaints on the liquidity front even after RBI made it clear it wanted liquidity to be in ?deficit mode?. Indeed, if the credit offtake has been lower than expected, it probably has more to do with corporates being unsure of recovery in the developed economies.
The good news is that the monetary policy is being transmitted effectively as is evident from the fact that money has become more expensive, especially after the central bank last raised rates in end-July. RBI mentions in its annual report that among the major factors weakening transmission in India has been the fact that a large proportion of the loans given by banks was at a rate that was below the benchmark prime lending rate. Apart from adding ?opacity to the assessment of transmission?, this practice also left banks with the option of under-charging big corporates at the cost of smaller borrowers. RBI has addressed this issue such that banks now have to announce a base rate below which they cannot lend; this is a major initiative on the part of the central bank and a big departure from the way banks were lending. Apart from making the lending mechanism more transparent, it will put in place a relevant benchmark for pricing loans. While initially, RBI had put out guidelines on how the benchmark should be arrived at, to its credit, it later withdrew them, allowing banks the freedom to price loans according to whatever benchmarks they believed were relevant. Although there may be some teething troubles, given time, both banks and customers should get comfortable with the new system.
Thanks to another major initiative of RBI, customers have been earning more on their savings accounts since May 2010. RBI also recognises the importance of freeing the interest rate on savings accounts; it?s possible there will be some action on this front soon. While the move could be potentially disruptive in the initial stages, with some banks losing out because of the change in the competitive landscape, they will have to learn to live with it. In order to protect customers it?s possible there will be a floor, perhaps of 3.5%, so that even when money is easy, savers will get some return on their money.
In a somewhat surprising move, the central bank said recently that CDS would be introduced; it?s admirable that despite the crisis in the western world, RBI is not reluctant to allow such sophisticated financial products. After several years, the central bank reopened the discussion on issuing new banking licences and on allowing large business houses into the banking arena. The discussion paper, however, had RBI?s conservatism and caution written all over it and it?s comforting to know that the regulator is well aware of the risks related to the presence of big business houses in a critical space like banking. RBI also plans to take a relook at the way foreign banks operate in India and has promised a discussion paper on the subject; its concerns in their functioning as branches are justified and it would certainly be easier for RBI to ring fence risks if they functioned as wholly-owned subsidiaries. But the more immediate challenge for RBI remains the containment of inflation without hurting growth.
Given that government borrowings are not likely to come down this year, RBI will need to ensure there is enough liquidity for the private sector and at affordable interest rates. One concern in this regard is the slow pace in the growth of deposits, which hasn?t hurt banks yet because there has been enough liquidity and not too much demand for credit. RBI still has some difficult times ahead.
shobhana.subramanian@expressindia.com