We are close to liquidity trap: Financial Express: 27th January 2009

The RBI has taken serious efforts to increase liquidity and lower interest rates in the last 4 months. Recognising that the industry was under pressure, the CRR was reduced by 250 bps, which meant an injection of around Rs 100,000 crore. Further, the repo rate was reduced swiftly in quick steps from 9% to 5.5%. While credit advance has been satisfactory with growth being 12.6% up to January 2 this year as against 11.0% last year, the pace of growth has not really accelerated.
In fact this number would also be higher on account of adjustments made every quarter. Further, lending rates (PLRs) have come down from an average of 12.75-13.25% last year to 12-12.5% this year. But, the average reduction of just 75 bps in PLR is very low when juxtaposed against the 350 bps reduction in repo rate. The issue is why is it that things have not gone quite according to the RBI’s plans considering that liquidity is in abundance today given the flow of bank funds into the reverse repo market?
Theoretically, we appear to be somewhere close to what Keynes had called the liquidity trap wherein the demand for money becomes flat meaning thereby that lower rates do not stimulate demand. This sounds okay under the present circumstances when there is an industrial slowdown with excess capacities in various industries. The slower pace of growth in infrastructure and housing has depressed overall demand. This is the macro picture. Maybe the government has recognised the same and invoked quite a few fiscal steps to resuscitate the economy.
Now, if we look at banks, their deposit rates have not really come down and the average rate on a 1 year deposit is at 8.25-10% as against 8.25-9% last year. What this means is that banks are vying for deposits and are willing to pay higher rates to attract deposits. Growth in deposits has been slower during the financial year so far at 13.2% (14.3%) as on January 2, 2009. There is evidently a shortage of savings, which is an enigma because we have a situation where people are not spending nor investing in the share market. Banks are hence, offering higher rates on longer maturities which mean that there is also a mismatch in assets-liabilities since they are betting on paying higher rates for longer tenures too. The focus of banks on infrastructure and housing, where the loans are for a period of 15 years, could be the explanation.
Now, quite a few industries have claimed that funds are not forthcoming from banks or are coming at a high cost.