The impact of the Reserve Bank of India’s (RBI) ‘exceptional’ liquidity tightening measures of July are being felt now, albeit in a roundabout manner and by way of a sudden surge in credit offtake from banks. Till around mid-July, the increase in bank credit during the current fiscal was trailing behind the growth in bank investments in government securities, which was clearly a reflection of the slowdown in the economy. Since then, banks have pared their sovereign paper holdings, while lending out much more than even the accretion to deposits. As a result, the outstanding credit-deposit ratio for scheduled commercial banks has hit a record 78.3 per cent as on September 20. The same ratio on an incremental basis, from July 12 to September 20, works out to 227 per cent. It only shows that deposit growth is simply failing to keep pace with the demand for bank credit.

However, this by no means is indicative of an economic recovery. The spurt in bank lending has been largely due to increased borrowings by corporates to meet their working capital requirements in an environment where interest rates on short-term debt instruments such as commercial paper rose sharply following the RBI’s mid-July tightening actions. Banks, in turn, have responded to this unexpected spike in credit demand by raising both deposit as well as lending rates. Some are even offering upwards of 10 per cent on deposits. The recently retired State Bank of India Chairman, Pratip Chaudhuri, has predicted that lending rates may also well go up as banks scramble for deposits, raising their own cost of funds.

The above trend is disturbing, especially as it comes at the start of the busy season for credit. Thankfully, the RBI under the new Governor, Raghuram Rajan, seems quite alive to the problems caused by tight liquidity. To start with, he has reduced interest on the marginal standing facility — the main borrowing window for banks from the RBI today — by 75 basis points. Secondly, the RBI has announced open market purchases of bonds worth Rs 10,000 crore next week which, hopefully, will be a precursor to more such auctions to help ease liquidity pressures. The central bank can probably afford to be more accommodative, now that a semblance of stability has returned to the forex markets. The Government, too, can help by not overshooting its fiscal deficit, which will end up ‘crowding out’ other borrowers and contribute to a further tightening of liquidity.

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