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The Reserve Bank of India, on expected lines, has increased the policy rates in its second quarter review of the monetary policy. Structural imbalances need to be addressed by the government, in addition to fiscal prudence to add teeth to the monetary policy measures.
The high interest rate regime has started to impact growth with baseline projections being pared down to 7.6 per cent from 8.0 per cent at the beginning of the year. Inflationary pressures due to high global commodity prices, domestic food prices, full impact of pass-through of hikes in petroleum prices and sharply depreciating rupee, will continue make it difficult for RBI to fight inflation.
Tight liquidity
Though the good monsoon may bring in some respite, fiscal measures are critical to support the monetary policy now. The benchmark 10 year G-sec yield is likely to rise, raising the government borrowing costs.
Liquidity is tightening, with banks' borrowing from the RBI rising to an average of Rs 84,000 crore in the last three working days from an average of Rs 36,000 crore in the first three weeks of October. The annual growth rate of non-food bank credit is at March 2011 levels at 21.31 per cent; however it has risen from the marginal dip to 19.68 per cent witnessed in June.
Deposit growth has picked up substantially, rising from 15.84 per cent in March 2011 to 19.20 per cent in September, reflecting the effect of increased interest rates and confidence in banking as a channel for savings despite near-negative real interest rates.
Welcome measures
The RBI has also made other announcements. Perhaps the most significant announcement has been on the deregulation of the savings bank deposit interest rate with immediate effect. The deregulation will now link both the assets and liability of banks' balance sheet to interest rate changes and bring in efficiency in funds management in banks.
The cost of funds for many banks dependent on CASA deposits will rise, but the depositors will now get a more market-determined rates attuned to inflation and policy rates. Banks will now have to focus more on managing asset-liability mismatches and fund management rather than relyon low cost deposits.
The NIMs of banks will also shrink and increasing focus will be on efficiently managing cost of operations. In effect, this will bring better efficiency in the banking system.
(The author is National Leader, Global Financial Services, Ernst & Young).
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