The Hindu Business Line : ‘We want to send definitive policy signals to lower lending rates’

Mumbai, April 21 “We want to send a definitive policy signal to banks that lending rates must come down.” This was RBI Governor, Dr D. Subbarao’s response when asked about what prompted him to resort to another round of rate cut now.

As RBI Governor, Dr Subbarao would have seen the maximum number of cuts in policy rates in a short span of time. Ever since he took over in last September, repo rate has been cut by 425 basis points and reverse repo by 275 basis points.

Dr Subbarao spoke to Business Line, explaining the thought process that went into making the annual policy, which announced 25 basis points cut each in repo and reverse repo. Excerpts:

The RBI has done quiet a lot in terms of reduction in key rates such as repo, reverse repo rate and CRR in the past few months, which provided ample liquidity. But real interest rates are still very high. What is the rationale behind cutting repo and reverse repo rates by 25 basis points at this point of time?

We have debated quiet a lot on that question. Whether policy rates should be adjusted further, if yes, then by how much? Is it advisable to do it now or defer it for sometime so that banks have enough time to respond to the policy rate cuts?

Having considered the pros and cons, we have decided that it is important to signal very definitively that we want lower interest rates. Therefore, we decided to cut the repo and the reverse repo rates by 25 basis points each to send a definitive policy signal to banks that lending rates must come down.

So far, only public sector banks have been responding to the rate cuts. Have you noticed that the rates of private and foreign banks are much higher than that of public sector banks?

Yes, I have noticed this. First of all, it is not correct to say that banks have not responded to policy rate cuts. The banks have responded. They have cut BPLR from 50-100 basis points. Also, banks have said that their policy response should not be evaluated by just looking at the BPLR, but by looking at the effective lending rate. As much as 70 per cent of the bank’s lending is done below BPLR, at the effective lending rate. The effective lending rate, which was 12.1 per cent in 2007-08, has come down to 10.5 per cent in 2008-09 and according to banks, even lower in the current financial year.

However, the response has varied across different banking segments.

For public sector banks, both credit and deposit growth has been higher. They have been followed by private banks and then by foreign banks. When the central bank posed the question to banks about passing the rate cuts further to the end users, there were two responses we got.

The banks told us that there were outliers who have not made the adjustment and we should not be misled by the outliers. Private banks have said that many of them have adjusted, but the number at the aggregate level is skewed due to some of the outliers.

Secondly, private and foreign banks have told us that it is a competitive environment and it is not possible for them to stop business altogether. They said, “We are lending and we are in business and we believe we can be in the business”.

The advice about reducing lending rates given to public sector banks has been given to the private and foreign banks as well. But I would not like to say that private and foreign banks have been less responsive.

Banks have been depositing on an average Rs 1 lakh crore with the RBI in the reverse repo window. Besides rate signals, in what other way can the RBI induce banks to lend more? A cap on the reverse repo window?

The RBI does not want to force banks to lend. We only give policy signals and in extraordinary times such as this, we urge them to exercise their judgement and expand credit being mindful at the same time about credit quality. We will not want a cap on the reverse repo window.

After the cut in the reverse repo rates today, do you see banks going out and lending rather than parking their funds with the RBI at 3.25 per cent interest?

We will have to wait and see. But the whole idea is that banks use the liquidity for credit and not for parking in our reverse repo window.

RBI has constituted a working group to review the present BPLR system? What has been the central bank’s concern?

The BPLR system was introduced in order to get some transparency into the bank lending structure. However, in a developing country like ours, there have to be certain priority sectors which cannot be left to the mercy of a total laissez faire system. Like agriculture and exports… However, as it happens, every sector wants to be a priority sector, be it housing or education loans. But if we make everything priority, then nothing is priority.

The intent behind this review is to see to what sectors really need priority lending and to minimise that and therefore to see that multiple lending and lending rates are determined by competitive market forces.

The RBI recently allowed banks to restructure loans. Do you think this could lead to an increase in the NPAs?

The restructuring decision was not a decision that we took lightly. Restructuring was not a new innovation. CDR mechanism has been there from 2001. In a downturn, it is necessary to see that economic agents get breathing space to manage their activity. So we had allowed a first restructuring of housing and real estate loans and a second restructuring for all other sectors. The intent was to see that those units which are inherently viable are able to manage in the downturn and not that every loan is restructures.

We have urged banks to do restructuring but also told them to use their judgment and restructure only those units which have inherent viability.

You mentioned about the possibility of the economy returning to the nine per cent growth trajectory. What would be the credit growth required?

At present, I cannot say on what credit growth would be required to fuel a 9 per cent growth. It will depend on what growth trajectory the economy will take. On whether it would be sharp jump from 6 per cent to 9 per cent or a gradual and slow movement, we will have to see. But I am hoping and believe that the recovery will be sharp because the drivers of our growth-domestic investment and domestic consumption are intact. There has been an erosion of confidence in the economic agents and that will come back.

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