The Hindu Business Line : Prudence over pep

Caution over exuberance seems to be the hallmark of the first quarter review of the Monetary Policy. And this is manifest in the Reserve Bank India's concern over credit offtake far outstripping the accretion to the deposit base rather than the modest hike of 25 basis points announced for repo and reverse repo rates.

With non-food credit growing 32.9 per cent while deposit accretion was of the order of 20.7 per cent, there can be no doubt that deposit growth lags far behind credit offtake. But is the situation spinning out of control to warrant such a call for alarm?

Surge in demand for credit

Most economists would view a surging demand for credit as a necessary pre-condition to rapid economic development. But concerns have been focused over the slow pace of deposit accretion rather than strong credit offtake.

Bankers have reason to be happy, however. The constant refrain over lack of demand for credit has not only been addressed but effectively redressed as well.

The sedate pace in credit offtake in the recent past was mainly on account of large corporate companies moving away from banks as a major source of funds to alternative and often less expensive sources such as the capital market, external commercial borrowings and the ADR /GDR route.

This left Indian banks with a huge corpus of funds with hardly any takers. The banks were forced to invest heavily in government securities, which were offering better returns.

Slowing growth

As the returns on government securities began falling, several banks recorded slower growth rates and some even reported losses.

But the banking sector showed its resilience and embarked on new and novel sectors to extend credit.

The growth in credit offtake to the housing sector grew at 115 per cent, commercial real-estate loans at 101 per cent, retail loans at 74 per cent, construction at 52 per cent, agriculture at 35 per cent and industry at 26 per cent — testimony to the change in the bank lending pattern.

These new and emerging sectors were the principal drivers of the current spate of credit growth. All of them have been development-oriented and the results have been encouragingly reflected in the balance-sheet of banks.

On the flip side, the growth in deposits has been impaired as the real effective returns both on savings bank and term deposits have fallen with the inflationary spiral.

New sectors such as real-estate, capital market and mutual funds have also been wooing the retail investments, often at the cost of banks.

It is, therefore, not surprising that growth in bank deposits has fallen relatively, to 20.7 per cent. However, one should also not lose sight of the fact that deposits grew by a mere 14.9 per cent in the earlier year.

Liquidity overhang

No bank has reported any asset-liability mismatch in its folio. Nor has there been any instance of serious liquidity crunch.

In fact, the reverse seems to the be the case with the economy burdened with a liquidity of Rs 91,231 crore under the Liquidity Adjustment Facility, the Market Stabilisation Scheme and government's reserves.

Also, banks are now finding the environment increasingly amenable to shore up their deposit portfolio. The recent rout in the capital market has diminished its sheen to millions of retail investors. The lure of heightened returns has waned from asset management companies and mutual funds.

Finally, some banks are offering eight per cent return on term deposits. All this may squeeze their margins further but the banking industry will definitely survive.

The real concern of the apex bank is in reining in the inflationary spiral and not in increasing the interest rates.

This is evident in the fact that the bank rate has been left unchanged, as also the CRR. But the move will increase the cost of short-term capital to banks. This in all likelihood will be passed on to customers.

Also, with the emergence of real effective demand for credit, banks will have to shore up the deposit base further.

For this, they will have to offer realistic returns for deposits, which prove attractive against the current inflation levels. As the cost and returns on funds go up for banks, they will go up for the customers as well.

Double-edged weapons

But monetary tools are invariably double-edged weapons. While the Government strives to contain the inflationary spiral by mopping up excess liquidity, the same moves can trigger firm trends in the interest rate regime.

This, in turn, will raise the cost of capital leading to increased production cost. There is every possibility that the rising cost of production will sooner or later have a cascading impact on the inflationary spiral.

It is therefore, not surprising that the RBI has just made nominal increases in the repo and reverse repo rates, while at the same time leaving critical parameters such as CRR and bank rate untouched. It is indeed a prudent move.

Once inflationary fears are addressed, the RBI can tighten repo rates and ease CRR and SLR to confront any liquidity crunch in the economy.

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