‘Market mechanism is best to bring rates down’

Reserve Bank of India Governor Raghuram Rajan has spent most of the past quarter fielding questions on why banks were not transmitting the RBI’s rate cuts.

When BusinessLine raised the issue today, he replied with just a touch of exasperation that he had done what he needed to do and it was now for the banks to figure out what they had to.

Hours later, three top banks (SBI, ICICI Bank and HDFC Bank) finally yielded to the persuasion and lowered rates a tad (15 to 25 basis points).

Asked about the difference in perception between him and banks on their cost of funds, he wondered if monetary policy had any effect on them. Then, his good humour returning, he said that we needed to take everything said by him and them (bankers) with an “appropriate amount of salt”.

Asked if it was possible to provide any further incentives to bring down rates, Rajan said the market mechanism of competition was the best incentive.

He pointed out that if banks didn’t lower their rates, the market would bring them down and the banks would lose business. Banks abroad had to benchmark their lending rates with an external benchmark, unlike what prevailed here, said Rajan.

Indian banks determine the way the base rate is computed, basing it on their costs.

“They have got lot of flexibility there. If they don’t exercise this flexibility fully, obviously it has to be pressure from competition that will force them to exercise that,” he said.

Inflation-indexed bonds

Rajan said the RBI was exploring the possibility of reviving the inflation-indexed bond, with a CPI linkage. This, he said, would involve committing to issue such bonds up to a certain level and perhaps even allowing for reissue of some securities, and having market makers to ensure liquidity.

He conceded that the earlier experiment to introduce such a bond last year had not succeeded, partly because of its WPI linkage and partly because liquidity was low.

The RBI Governor also said that “the preliminary success in the fight against inflation” had forced people to focus less on inflation-indexed bonds.