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RBI credit policy may cut interest rates

With inflation more or less under control, the credit policy for the second half of fiscal 1997-98 -- the so-called busy season -- is likely to address the issue of economic growth. Reserve Bank of India Governor Dr Chakravarty Rangarajan will unveil the policy on Tuesday, October 21

Thanks to more elbow room provided by low inflation -- it is currently a shade over four per cent -- the RBI may bring down interest rates further. A cut in the cash reserve ratio, reduction in the preference bank rate, rationalisation of interest rates and greater integration of financial markets with overseas markets are among the major policy measures the RBI may announce in its credit policy, leading bankers said.

"Monetary policy will be generally supportive in bringing down interest rates. As the rate of inflation remains at a reasonable low level and inflationary expectations are broken, it should be possible to bring down the nominal interest rate," Dr Rangarajan had said in his July 25 speech at the All India Manufacturers Organisations meet.

The need for lowering interest rates chiefly arises from slow industrial growth, notwithstanding some positive signals from recent estimates of the Central Statistical Organisation showing that industrial production grew by 6.4 per cent between April and July.

The question is: What is an appropriate interest rate? According to Dr Rangarajan, an appropriate interest rate that would encourage saving and investments depends on the relative elasticity of saving and investment to interest rate. Analysts say any tinkering with the interest rates has to be done keeping in mind the possible impact on domestic savings -- vital for investment and growth.

Dr Rangarajan expressed the hope in his address to the Uttar Pradesh Chamber of Commerce in Kanpur on Friday, October 17, that the economy could sustain a steady growth rate of seven per cent this fiscal year too. But in an earlier speech in Bombay, the RBI governor had placed some conditions on such rapid growth.

The issue, Dr Rangarajan said, had to be addressed on the basis of availability of resources and the possible "physical, structural constraints in the economy... An improvement in the domestic saving rate would constitute the most critical factor for accelerating the growth of the economy," he said.

While some bankers expect a phased one per cent point cut in the cash reserve ratio to ensure better liquidity in the banking system, the experience between the slack season policy and Tuesday's policy show that the real problem is not the lack of lendable resources, but the lack of demand for them, despite most banks reducing prime lending rates.

While money supply has been growing at 16 per cent to 16.5 per cent during the current fiscal year, slightly ahead of RBI's target of 15 per cent to 15.5 per cent, the sluggish inflation rate shows that more money is being held as idle cash balances rather than being made to fuel demand for goods and services.

Many analysts agree with Dr Rangarajan's explanation that "the depressed capital market has also played its role in the deceleration of bank credit to the commercial sector." There has to be a balance between debt and equity," he said.

Other experts said the twin objectives of the RBI's first half credit policy -- price stability and increased bank finances to industries -- had been partly successful. While the Reserve Bank has contained inflation in spite of a recent petroleum hike, it failed to enhance the bank credit flow towards industrial production though banks had sufficient funds and despite the lending rates going down regularly.

There was no need to infuse additional funds, but to increase confidence through a free and transparent environment without threat of harassment from law-enforcing agencies, K Kanan, Bank of Baroda chairman, said.

Kanan said bankers had to be freed from bureaucratic shackles to give funds to eligible borrowers. The government must work together with industry and banks to enhance the flow of funds to the core sector for greater productivity. Today, decision-making has slowed down significantly with huge production capacity in various industries lying low, he said.

Many bank economists felt that lowering interest rates would give only a small impetus to demand and growth of bank funds; it was more important to allow the banks to take bigger risks while the government stepped up investments and spending on infrastructure development.

But such policy initiatives might call for easy liquidity in the system at lower interest rates and so the RBI was likely to reduce rates by 0.5 to 1 percentage point. While analysts expected short-term deposit rates as well as lending rates to decrease further, they said measures on paper without corresponding changes in actual conditions would not aid industrial growth, which is constrained by a fiscal cutback, infrastructure bottlenecks and sluggish exports.

Analysts from Merril Lynch felt the RBI would bring about closer integration of the debt, credit money and foreign exchange markets and further deregulate interest rates.

The analysts said the RBI could allow foreign exchange and money market dealers to lend and borrow funds in overseas markets to bring some parity between domestic interest rates, forward premiums and overseas rates.

The central bank could also bring in some provisions to liberalise the capital account, but major moves may take time since the Foreign Exchange Management Act is yet to be passed in Parliament.

Since last October, the RBI has been easing liquidity and lowering interest rates. But industrial growth rates have still shown a sharp decline.

Though there was an increase in the growth rate in the first quarter of the current fiscal year to 5.14 per cent, it was far below the RBI's target of 10 to 11 per cent for the year. The bank now expects a more realistic industrial growth rate of seven per cent during the current year.

Some experts don't believe the credit policy will cause any significant improvement in corporate earnings, even if there is a reduction in CRR and interest rates. This credit policy should focus on being growth-oriented and demand-generative, they said.

One person who advocates lower interest rates was Federation of Indian Export Organisations president Ramu S Deora who felt a cut in interest rates, either to international levels or at least to those prevalent in neighbouring countries, would reduce the pinch on exporters who have to struggle in a competitive global market.

Deora also suggested that export units be given soft loans at LIBOR rates to the tune of Rs 250 million to Rs 500 million to upgrade technology and modernise plants. Acquisition of a quality certificate like the ISO should also be funded under the scheme, he said.

Among the most enthusiastic was M Roy, senior director at the Confederation of Indian Industry. "We are expecting a historic credit policy which will stimulate the economy," she said.

UNI