Showing the way forward: Financial Express: 22nd April 2009

RBI has done what it could to assuage the markets. RBI, as we all know, can only provide direction to interest rate movements but cannot force banks to follow suit. Nor can it force banks to lend more money to any sector. The lowering of the repo and reverse repo rate is a clear signal to banks to reduce rates for industry in particular. The fact that inflation is benign has helped the central bank to take this decision. The focus is evidently on growth, now that the global economy is expected to recover only in 2010; and attaining a growth rate of 6% for India under these circumstances is going to be a challenge.
The credit policy has been geared to provide direction to future monetary activity, and hence deserves to be analysed within the parameters laid down. To begin with RBI has assumed that non-food credit would grow by 20% in this year. Last year, the outstanding credit stood at around Rs 28 lakh crore, which means that incremental credit will be Rs 5.6 lakh crore. Deposits are expected to grow by 18%, which again on a base of around Rs 38 lakh crore means an increase of Rs 6.8 lakh crore in incremental deposits. Of this 5% would be kept aside for CRR, which in turn would make around Rs 6.5 lakh crore available to banks.
The difference between the two would be Rs 0.9 lakh crore, which under normal circumstances would not be an issue for the economy. However, net government borrowing for the year is expected to be Rs 3.1 lakh crore. This leaves behind a gap of Rs 2.2 lakh crore for the year, if things work out this way. Where will this money come from?
RBI has mentioned pushing in around Rs 1.2 lakh crore (which is equivalent to around 3% points cut in the CRR) through unwinding of MSS bonds and OMO purchases, but that will still leave behind a gap of Rs 1 lakh crore. As banks have an investment deposit ratio of over 30%, the sale of bonds to the extent of Rs 70,000 crore should not really matter as it would still mean the maintenance of the SLR of 24%, with the balance being financed through the MSS route. This means that RBI will have to lower the CRR further during the year to provide liquidity, or else be prepared for a higher interest rate regime.
It may be recollected that lower interest rates last year did create a liquidity problem for banks which had to raise their deposit rates in order to garner funds. Growth in deposits this year has been taken to be lower at 18% compared with almost 20% last year. Under these circumstances, it would be difficult to actually think of lowering interest rates during the year.
RBI is, in fact, talking of fairly modest economic growth and has hence posited a credit growth rate of 20% this year. To eschew a liquidity crunch, it has to hope that this number does not materialise or that deposits increase faster. But, intuitively one can see that a lower economic growth rate is associated with a lower savings rate as households, which is the dominant savings group actually diverts its income to consumption, or rather maintenance consumption. This will make it hard to enhance the deposits growth rate.
Another imponderable is the government deficit. One is not quite sure if this number will be maintained and a clear picture will emerge once the new government is in power. This is critical because with the government being against monetisation of the deficit, any further borrowing will only strain the system.
The major concern for industry is the delivery of credit, especially with there being surplus funds of around Rs 1.2 lakh crore in the system today. Prudence will dictate that RBI should try and take use these surplus funds through an accelerated borrowing programme so that the funds do not lie idle with the banks. As this is the slack season when typically there is less pressure on funds, the period post august could be the time when industry could be involved in the credit process.
Therefore, the overall liquidity situation and interest rate movements will require constant monitoring this year as all the three variables: deposits, credit and government borrowing have been projected based on certain assumptions, which could change.