The reality on rates
Hindu Business Line, January 22, 2010, Page 8
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By its own admission, the RBI's easy money policy has not worked as well as it should have. A reversal of the policy now would simply ratchet up an already high real interest rate regime.
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One issue that the Reserve Bank of India (RBI) should consider in its third quarter review due next week is the impact of administered rates on its key monetary policy changes. The Governor, Dr D. Subbarao, has repeatedly pointed to the way administered rates on small savings, among other factors, jammed its signals for cheaper lending by banks. The interest rate of 8 per cent for deposits under small savings schemes set the floor for banks as a result of which lending rates fell far less than the central bank's own aggressive reductions in the cost of funds called for.
That was last year when the RBI was aggressively pursuing a soft interest rate policy. Now it is set to weigh its options about tightening a bit. Given the headline inflation of around 7 per cent and the likely effects of bountiful liquidity on its upward movement, the natural tendency for Dr Subbarao would be to push the buttons for tighter money so as to skim off any excess demand. However, before doing so, the RBI should recall its critique on administered rates. Despite itself and by its own admission, its easy money policy has not worked as well as it should have in making domestic capital cheap. Under the circumstances, any reversal of the easy money policy now would simply ratchet up an already high real interest rate regime. As it is, the enthusiasm for bank credit is just picking up as the latest data show; sending signals out for dearer money could dampen that pick-up at a time when it is most needed to rev up investment growth. The RBI surely knows that its signals for higher interest rates work far better than those announcing a dip; administered rates after all set the floor not the ceiling. That is exactly why the RBI must view a rate or cash reserve ratio (CRR) hike this month with some reservation. Domestic rates have been historically high, a feature that had Indian firms scurrying for cheaper global capital during the period of high growth till 2008-09. The only way to change that pattern is for the RBI to curb external commercial borrowings or for its signals for softer rates to work effectively.
Dealing with administered rates and government borrowings, whose ever-increasing size also prevent bank rates from falling, is New Delhi's job; it may be easier to control the need for funds than it will be to reduce rates on small savings or abolish administered rates altogether. But as financial services acquire sophistication, that task too could be tackled without hurting the interests of the small saver.
Hindu Business Line, January 22, 2010, Page 8
--------------------------------------------------------------------------------
By its own admission, the RBI's easy money policy has not worked as well as it should have. A reversal of the policy now would simply ratchet up an already high real interest rate regime.
--------------------------------------------------------------------------------
One issue that the Reserve Bank of India (RBI) should consider in its third quarter review due next week is the impact of administered rates on its key monetary policy changes. The Governor, Dr D. Subbarao, has repeatedly pointed to the way administered rates on small savings, among other factors, jammed its signals for cheaper lending by banks. The interest rate of 8 per cent for deposits under small savings schemes set the floor for banks as a result of which lending rates fell far less than the central bank's own aggressive reductions in the cost of funds called for.
That was last year when the RBI was aggressively pursuing a soft interest rate policy. Now it is set to weigh its options about tightening a bit. Given the headline inflation of around 7 per cent and the likely effects of bountiful liquidity on its upward movement, the natural tendency for Dr Subbarao would be to push the buttons for tighter money so as to skim off any excess demand. However, before doing so, the RBI should recall its critique on administered rates. Despite itself and by its own admission, its easy money policy has not worked as well as it should have in making domestic capital cheap. Under the circumstances, any reversal of the easy money policy now would simply ratchet up an already high real interest rate regime. As it is, the enthusiasm for bank credit is just picking up as the latest data show; sending signals out for dearer money could dampen that pick-up at a time when it is most needed to rev up investment growth. The RBI surely knows that its signals for higher interest rates work far better than those announcing a dip; administered rates after all set the floor not the ceiling. That is exactly why the RBI must view a rate or cash reserve ratio (CRR) hike this month with some reservation. Domestic rates have been historically high, a feature that had Indian firms scurrying for cheaper global capital during the period of high growth till 2008-09. The only way to change that pattern is for the RBI to curb external commercial borrowings or for its signals for softer rates to work effectively.
Dealing with administered rates and government borrowings, whose ever-increasing size also prevent bank rates from falling, is New Delhi's job; it may be easier to control the need for funds than it will be to reduce rates on small savings or abolish administered rates altogether. But as financial services acquire sophistication, that task too could be tackled without hurting the interests of the small saver.
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