In reducing the key policy rate (repo) by 25 basis points and retaining the Cash Reserve Ratio (CRR) at the current level, the Reserve Bank of India (RBI) has struck a fine balance between growth and price stability. It has explained well the rationale for its decisions in the macroeconomic document as well as in the policy review.

What impresses one is the somewhat subdued and realistic assessment of growth prospects at 5.7 per cent against the 6.1-6.7 per cent in the Economic Survey and 6.5 per cent in the Budget Speech. There is nothing in the existing economic situation, either in the country or abroad, that would warrant projecting a higher growth than what the RBI estimates.

I am also satisfied to note its moderate estimate of the growth of money supply at 13 per cent by not adopting the new normal inflation rate of 6.5 per cent assumed by the Finance Minister. (See “Monetary Policy for the aam aadmi ”, Business Line , May 1).

One hopes that money supply growth will be contained within the estimated limits, despite the prospects of election within a year and the consequent tendency of government to engage in populist measures. The RBI expects WPI inflation to be around 5 per cent by the end of the year.

Liquidity in the system

Will the repo rate cut lead to any reduction in lending rates? Recent experience does not support the view. During the last two financial years, the central bank injected into the system Rs 2,70,000 crore through its so-called open market operations by way of debt buybacks. The CRR was reduced from 6 per cent to 4 per cent increasing primary liquidity by another RS 1,30,000 crore.

The reduction in policy rates was of the order of 100 basis points between January 28, 2012 and March 19, 2013. Credit conditions need to be assessed both in terms of availability and cost.

The transmission of all the liberalising measures to the system to the benefit of borrowers has not been full and adequate.

All the money has gone only to validate the prevailing high level of prices and the fall in the purchasing power of the money, thanks to the double-digit inflation in consumer prices.

The heavy repo operations of banks at the RBI reflect the arbitrage opportunities available to them with securities fetching a better return vis-à-vis the repo rate that also explains the excess SLR investments. It does not represent any liquidity problem.

The space for banks to reduce rates is limited due to the stringent provisioning norms introduced recently by the RBI.

According to a rating agency estimate, it will result in a reduction of Rs 15,000 crore from bank earnings affecting their profits by 7 per cent between April 2013 and March 2015. Bankers say that provisions are a major factor in deciding on the interest rates.

It is heartening to see the absence of any reference to the concept of ‘‘core inflation’’ for the first time. Instead, the more neutral ‘‘non-food manufactured products inflation’’ is the expression one finds in the RBI documents. Thank you, RBI!

One disquieting feature of the RBI documents is its failure to flag two issues of fundamental importance to the system, nay, to the economy. They are the mismatch between assets and liabilities and the rising non-performing assets. 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. On the other hand, loans and advances maturing within a year to the total were at 35 per cent. The ALM funding gap is 15 per cent. Underlying this percentage is a large amount of money in absolute terms.

What’s missing

The asset-liability mismatch (ALM) is even more if one takes into account the liabilities of banks due to borrowings. It is the result of banks increasingly turning to medium and long-term advances both on grounds of profitability and pressures from government to finance investment proposals.

There is a moral hazard in the government standing behind a public sector bank in case of distress. Recently, we have seen the case of Cyprus where, under an international bailout scheme, depositors were forced to take major losses on their savings over €100,000.

The lender of the last resort function of the central bank is the only facility that is justified in case of temporary shortage of liquidity. This takes us to the related problem of non-performing assets (NPAs) that aggravate ALM.

Rising bad loans

According to available data, gross NPAs for all banks was 3.6 per cent of gross advances at the end of September 2012. They are expected to reach 4 per cent by March 2013 and 4.4 per cent by March 2014. Public sector banks’ stressed assets rose to 11.6 per cent of the total, as on end-December 2012, from 6.7 per cent a year before.

The average size of restructured loans is reported to have increased by 14 per cent to Rs 590 crore.

According to the RBI circular letter of November 21, 2012 a major reason for deterioration in the asset quality of banks is the lack of effective information sharing among banks regarding their credit, derivatives and unhedged foreign currency exposures.

Further, lack of effective and timely information exchange among banks may also result in occurrence of frauds.

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

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