S S Tarapore

Finally, RBI cracks the whip

S.S. TARAPORE | Updated on May 06, 2011 Published on May 06, 2011

The RBI Governor, Dr D. Subbarao… The rate hikes are necessary inview of the need to reduce the inflation rate   -  Bloomberg

The 50-basis-point increase in repo and reverse repo rates is entirely justified in the current monetary and economic environment. The government, too, has accepted the reality that growth may have to be sacrificed for inflation control.

From a stance where its loud bark was accompanied by baby bites, the Reserve Bank of India (RBI) is now concerned that inflation is strongly embedded in the system and that price pressures are spilling over into generalised inflation.

The RBI accepts that inflation in the first half of 2011-12 could remain at around 9 per cent and it is hoped that it will fall to 6 per cent by March 2012, which would still be above the RBI's comfort zone of 4.0-4.5 per cent.

RIGHT APPROACH

A slowdown in growth in 2011-12 is inevitable. The RBI's baseline real growth is put at 8 per cent and, in view of the uncertainties, the growth rate could range between 7.4-8.5 per cent. It is now recognised by the government that some slowdown in growth is inevitable if inflation is to be brought down to acceptable levels.

Consistent with the growth and inflation outlook for 2011-12, RBI has projected M3 expansion for 2011-12 at 16 per cent, deposit growth at 17 per cent and non-food credit expansion at 19 per cent. These projections would imply that the incremental credit–deposit ratio would come down from an unsustainable 95 per cent in 2010-11 to 83 per cent in 2011-12, and even this would be unsustainable given reserve requirements. It is against this backdrop that the measures of May 3 should be assessed. The market was conditioned to baby steps and only in this context does the 50 basis point increase in the repo rate appear high. But this increase is clearly justified in view of the overall monetary situation and the need to reduce the inflation rate.

The RBI has done well to follow the sagacious advice of the Mohanty Working Group on Operating Procedures of Monetary Policy and moved over to a single independently varying policy rate to signal the stance of monetary policy. The reverse repo rate will be fixed at one percentage point below the repo rate and as such this would no longer be an independent rate.

Under the new Marginal Standby Facility (MSF), banks will be allowed to borrow overnight up to 1 per cent of their net demand and time liabilities at one percentage point above the repo rate.

Thus, with the repo rate in the middle, which would be independently set as the policy rate, the MSF would be one percentage point above the repo rate and the reverse repo rate would be one percentage point below the repo rate and thus the corridor would be 2 percentage points.

Predictably, the RBI may have found it too drastic to implement the recommendation on the Bank Rate. It would be best that RBI expeditiously implements the Mohanty Working Group's recommendations on the Bank Rate and other recommendations in 2011-12.

SAVINGS DEPOSITS

More recently, the RBI has come out with an excellent discussion paper on deregulation of the savings bank deposit rate -- this paper reflects the RBI at its best. Pending a decision on the issues raised, the RBI has done well, as an interim measure, to raise the savings bank deposit rate from 3.5 per cent (fixed) to 4.0 per cent (fixed).

On the issues raised in the discussion paper, the RBI has sought feedback from the general public on a number of crucial issues. In this connection some responses are set out seriatim:

(i) The time is apposite to further the deregulation process.

(ii) Initially, the savings bank deposit rate could be prescribed as a range, say 4.0-5.0 per cent. Banks should be strongly counselled to use the discretion with finesse so that their net interest margins are protected. Once banks show maturity and judgement, the ceiling could be dispensed with, but the floor rate should be retained.

(iii) The process of deregulation suggested above would ensure that small savers are not affected.

(iv) As the experience of deregulation of term deposit rates in the late 1990s showed, a well modulated process of deregulation would ensure against any adverse effects.

(v) Each bank should be required to ensure that their savings bank deposit rate is uniform for all depositors of the bank. The institutional memory of the 1977-78 experiment would advise against separate interest rates for deposits with cheque book facilities -- in 1977-78, all depositors with cheque book facilities opened two accounts.

In the proposal now under examination cheque book facilities should be subject to increased charges, and there should be charges for excessive credit/debit entries. Moreover, interest should not be paid on any daily amount in the savings bank account above, say, Rs 2 lakh. There is a crying need to reform the present savings bank deposit rate and the phased deregulation should be completed in 2011-12. The development and regulatory policies have been well constructed and deserve separate treatment.

(The author is an economist. >blfeedback@thehindu.co.in)

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Published on May 06, 2011
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