A Conventional Intervention

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The RBI initiates an economic stimulus, hoping its policy rate change will induce commercial banks to increase lending, says Saumil Sharma

Low business The RBI must help resurface credit demand in the markets
Low business The RBI must help resurface credit demand in the markets
Photo: Reuters

ALTHOUGH THE IMF and the World Bank have forecast 5.25 percent and 4 percent GDP growth for the Indian economy in 2009-10, the Reserve Bank of India (RBI) still maintains its projection of 6 percent growth in its annual policy statement for this fiscal. And Prime Minister Manmohan Singh seems determined that the Indian economy will be back with a growth rate of 8 percent after September 2009.

As a central bank, the RBI has maintained liquidity in the system and sufficiently supported banks and other institutions in the country, but that is only one side of the coin. The ongoing parliamentary election have effectively left the RBI in charge of the economic stimulus India requires during this crucial period. It, therefore, needs to take on a commercial bank’s role while conditions of lending and credit still face difficulties. For the economy to grow at a higher level, counter-cyclical lending by commercial banks is necessary and the RBI will have to directly oversee timely policy changes according to market conditions.

Following the global financial meltdown, the RBI resorted to adjusting the Cash Reserve Ratio (CRR) and undertook Open Market Operations to maintain sufficient liquidity. In its annual policy report for 2009-10, it issued a rate cut of 25 basis points in the repo and reverse repo rate, to make them 4.75 and 3.25 percent respectively, indicating a need for commercial banks to ease their lending rates.

The polls have left the RBI in charge of the economic stimulus India now needs

The annual report notes that in the last two quarters, the RBI has reduced its lending rates by 400 basis points but the reduction in the range of the Bank Prime Lending Rate (BPLR) was only 125-225 basis points (for public sector banks), followed by 100-125 basis points (for private sector banks) and 0-100 basis points (for five major foreign banks).

Clearly, the recent monetary easing by the RBI has not been fully reflected in the reaction of commercial banks towards lending rates, partly because of a lag between policy change and market implementation.

For the past two quarters, most conventional monetary controls exercised by the RBI, although necessary for handling liquidity issues, have been focused on conventional ways to exude or absorb money flows. There hasn’t been much unconventional monetary management to create ease in credit conditions. And this, in turn, is impacting the economy in one way or the other.

Consider this. The declining growth in the credit market and fall in credit demand has also tended to deteriorate financial assets: for instance, non-performing assets (NPAs) of commercial banks have ballooned. According to a recent report by the Credit Rating Information Services of India Limited (CRISIL), the slowdown will drive the gross NPA valuation in the banking sector to a projected five percent of total bank advances by end March 2011 — from just 2.8 percent in end March 2008. “The increase in NPAs will be driven by delinquencies in corporate loans; this asset class accounts for about 56 per cent of banks’ advances,” points out Raman Uberoi, senior director, CRISIL, adding that deterioration in the asset quality of corporate loans will be the result of slowdown in demand, lack of access to funding at reasonable rates, movements in foreign exchange rates and a lengthening working capital cycle.

OBVIOUSLY, THE vicious cycle of credit losses starts with difficulties in credit availability to a market that requires lending. This results in an eventual loss of demand in asking credit to facilitate economic activity. This loss of demand is a reflection of low confidence of the market in raising credit from institutions, while business volumes and profits are trickling. As a result, India — for some strange reason — faces a peculiar situation where the RBI’s efforts have genuinely created an ease of liquidity in the market but commercial banks — both stateowned and private — have found it increasingly difficult to pursue renewed credit lending while corporate profits have continuously declined.

The distortion of credit cycles in the market is underlined by the RBI’s report which states that business confidence is low and credit demand needs to be driven. Currently RBI’s liquidity support has helped in bringing some stability to financial markets and maintaining sufficient foreign reserves to handle the balance of payments. What is still lacking, however, is a bold statement to bring self-assurance to credit markets and resurface lost credit demand. It’s a crisis of confidence that needs a courageous central bank to make a leap into the unknown.

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