RBI wants administered interest rates revisited

RBI wants administered interest rates revisited
The Financial Express, June 6, 2009, Page 1

Sunny Verma, New Delhi

The Reserve Bank of India (RBI) has asked the government to take up a comprehensive review of the administered interest rate regime-including rates on small savings schemes and the savings bank rate-in order to nudge banks into reducing their market interest rates. This would also help lower the cost of the government’s own expanding borrowing programme.

In a meeting with finance minister Pranab Mukherjee on Thursday, which lasted for more than 40 minutes, RBI governor D Subbarao is learnt to have expressed the view that deep rate cuts by banks were difficult without further deregulation of the interest rate structure. This was Subbarao’s first meeting with Mukherjee after the minister took charge.

Mukherjee will meet with heads of pubic sector banks next Wednesday to steer them towards what he has called a “more benign” interest rate regime. The banks have told the finance ministry they can cut their benchmark prime lending rates (BPLRs) by only 25-75 basis points, a senior official told FE.

In the interim Budget, the government pegged its borrowings for 2009-10 at Rs 3.62 lakh crore, which is likely to rise when Mukherjee presents Union Budget 2009-10 on July 3 in Parliament. A 1-percentage point reduction in interest rates would result in estimated savings of Rs 1 lakh crore for the Centre on interest payouts on outstanding government securities, a government official pointed out.

“Small savings rates are administered rates of interest. They should also be adjusted from time to time. But they were not revised upwards when deposit rates rose. One needs to see whether they can be lowered now. They need to be examined afresh,” C Rangarajan, Rajya Sabha MP, former RBI governor and chairman of the Prime Minister’s Economic Advisory Council told FE.

In its annual review of monetary policy 2009-10, RBI said rates on small savings schemes such as the Public Provident Fund, Kisan Vikas Patra and post office monthly, which offer an 8% annual return, acted as a floor for deposits rates. This prevented deep cuts in banks’ lending rates, despite an aggressive reduction in the central bank’s policy rates.

Costly credit and slackening demand weighed down credit growth to a five-year low of 15.9% year on year as of May 22, RBI said in its weekly statistical supplement released on Friday. Deposits were up 22.6% from a year earlier.

“There is no easy answer (on interest rate adjustment) in the present context. The cost of funds to banks is high. If the government can reduce the cost of credit, that will be welcome,” Rajya Sabha MP and former RBI governor Bimal Jalan told FE.

Any move to tinker with small savings rates will have to be carefully calibrated as sustaining the country’s high domestic savings & investment rate is as crucial to economic growth as is easier credit access to India Inc. There is one view in the policy establishment that if the government is going to widen the social safety net in the upcoming Budget, as indicated by President Pratibha Patil on Thursday, there would be some headroom to pare the savings bank rate and small savings rates.

The savings bank rate, currently at 3.5%, has been reduced by only 150 basis points in the last 15 years, by 50 bps each in 1994, 2000 and 2003.

One percentage point is 100 basis points. The reverse repo rate, currently at 3.25%, is now below the savings bank rate. Conventionally, reverse repo has served as a sort of floor on other policy rates, including the savings bank rate.

Two other administered rates--loans to farmers at 7% and export loans at 250 bps below PLR--are, however, unlikely to be reviewed. But the government is considering a 1% rebate to farmers who repay loans on time.

The repo rate (the rate at which RBI lends to banks) has been reduced by 425 basis points since September, while reverse repo (the rate at which banks lend to RBI) has been pared by 275 basis points. But commercial banks have been able to cut their PLRs by only half as much in the same period.

Another key monetary policy tool is the cash reserve ratio, the slice of deposits that banks are mandated to keep with RBI, which is currently at 5%. The bank rate, which reflects the RBI’s view on long-term interest rates and long-term inflation, is at 6% and is unlikely to be touched. SLR, or statutory liquidity ratio (the percentage of deposits that banks need to invest in government securities) is at 24%.

Savings of Indian households were Rs 7,34,653 crore in 2007-08, of which over 55%, or Rs 4,06,630 crore, is held as bank deposits, according to the latest RBI figures. Bank deposits as defined by RBI include cooperative non-credit societies.

The National Small Savings Fund witnessed withdrawals of Rs 5,937 crore in 2008-09, according to the controller-general of accounts data, as investors parked funds in more lucrative avenues like fixed deposits, mutual funds and equities. However, the middle-class’s favourite investment option, PPF, garnered Rs 5,013 crore in 2008-09.

RBI has already initiated a review of the BPLR system when it unveiled the 2009-10 monetary policy in April. It argued that BPLR has lost its relevance as a meaningful reference rate, as over 70% of loans are now advanced below this benchmark. “Furthermore, this impedes the smooth transmission of monetary signals and makes the loan-pricing system non-transparent,” RBI said.

The central bank also proposed that payment of interest on savings bank accounts be calculated on a daily basis from April 1, 2010, as opposed to the present system of calculating it on the minimum balances held in accounts between the 10th and last day of each calendar month. This would roughly raise banks’ interest payout by around Rs 7,100 crore on the banking system’s outstanding savings deposits of Rs 1.01 lakh crore.