A refreshing contrarian

Once again, it is time for the markets to speculate on what the Reserve Bank of India (RBI) is going to announce on June 17. The economic problems facing the nation are no different from what they were when the annual policy was announced.

The situation on the price front is so desperate that a few basis-points decline in either the wholesale or the consumer price inflation has become the signal for cheer for vested interests.

Thus, the annual fall in WPI inflation from 4.89 per cent to 4.70 per cent and that in CPI from 9.39 per cent to 9.31 per cent between April and May this year are cited in favour of a relaxation in policy. In both cases, food inflation is high and rising; in CPI, it is still around the double-digit level.

The latest reports are not encouraging either. Ginger, the lowly vegetable for the common man, sells at Rs 250 per kg in Mumbai! It is not an isolated instance.

Although the non-vegetarian population is large, the newspaper reports do not highlight the equally bad situation prevailing in their case. Why does no minister or government official raise his voice against injustice to the poor, especially those below the poverty line?

Asset-liability mismatch

It is reassuring that the Governor of the RBI has been lobbying the case for the poor man. He has pointed out more than once the regressive nature of price rise as a tax on the aam aadmi as the raison d’etre for his monetary stance. The nation is grateful to him for his lonely walk on the path of disinflation. He is doing to India what Paul Volcker did to the US in the 1970s and 1980s.

Though the latter was blamed for ushering in recession, subsequently, there was a long and sustained stable growth of the economy, once the demon of inflation was pinned down from a peak of 13.5 per cent in 1981 to 3.2 per cent by 1983. He had raised the Federal funds rate from an average of 11.2 per cent in 1979 to 20 per cent in June 1981.

The idea behind the Bank lowering its policy rate is that it will be transmitted by the banks to its customers. But the record has not been reassuring.

Since April 2012, the central bank has reduced the repo rate by 125 basis points (bps). Against this, the base rates for the banking system have fallen by only 40 bps despite the massive repo transactions. Why is it so? It is due to unsatisfactory asset-liability management (ALM).

According to Statistical Tables relating to Banks in India 2011-12 , at the end of March 31, 2012, the proportion of total deposits in all banks maturing within one year was 50 per cent.

Yielding to bonds

On the other hand, loans and advances maturing within a year to the total were at 35 per cent. The ALM funding gap was 15 per cent. The need to garner deposits has made the interest rates somewhat inflexible. It has, in turn, made the lending rates rigid and non-responsive to changes in policy rates.

A consequence of the asset-liability mismatch is the boost to the bond market with reductions in yields. Monetary policy has had a greater influence in influencing yields of bonds than loan rates. An important factor distinguishing bonds and loans is that the former — mainly government securities (G-secs) — can be liquidated easily, unlike loans.

It is this enhanced liquidity that encourages the system to prefer bonds to loans to meet situations of emergency.

There is also the repo window at the RBI that makes surplus SLR securities liquid, but the system has made use of (or misused) the facility for refinancing by sustained access for large amounts day after day.

I feel, given the choice of refinance or the repo, banks will prefer the latter, ceteris paribus .

Refinance for the preferred export credit sector is at repo rate. However, despite the enhancement in the ceiling for its eligibility from 15 per cent of outstanding loans to 50 per cent, the utilisation by the system is partial.

Buoyancy in G-secs

Recently, the RBI Governor pointed out that unutilised export credit refinancing amounted to Rs 21,000 crore.

An additional advantage in investing in G-secs is the relatively favourable provisioning requirements as against those for loans in the context of the rising non-performing assets.

Obviously, banks with a relatively high proportion of deposits in current and savings accounts find the net interest margin in G-sec investments acceptable, other things remaining the same.

The buoyancy in the government securities markets is evident from the fact that outright transactions increased from Rs 1,73,100 crore on May 18,2012 to Rs 11,02,700 crore on May 17, 2013.

In May 2013, the RBI announced a reduction in its policy rates by 25 basis points. The response of banks has been feeble. But the bellwether 10-year bond rate fell by more than 40 bps.

On June 6, the 8.15 per cent G-sec maturing in 2022 closed at an yield of 7.41 per cent. The coupon of the newly-issued 10-year bond, which becomes the latest benchmark, was set at 7.16 per cent. It was lower than even the prevailing repo rate.

All this is happening despite the heavy market borrowing programme announced by the Government for the current year.

(The author is a Mumbai-based economic consultant.)

COMMENT NOW