Duvvuri Subbarao, governor of the Reserve Bank of India (RBI),
has called on banks to reduce their deposit rates in order to
lower lending costs.
He believes that this is the key to boosting credit growth as
Indias economy slows and high government borrowing places
upward pressure on interest rates.
Subbarao told Emerging Markets
in an interview:
We want a lower interest rate regime and ... banks must
reduce their lending rates if necessary, by reducing deposit
rates in order to meet credit supply.
On April 21, the RBI cut its repo and reverse repo rates by 25
basis points (bps) each, to 4.75%. The RBI has now cut its key
lending rate by 425 basis points since mid October 2008, while
injecting massive liquidity to jumpstart sagging private
economic activity. It now forecasts 6% growth this year
the slowest pace of growth since 2003.
Commercial lending rates are not being reduced as fast as the
RBI wants, often because institutions are seeking to shore up
their capital base while asset quality deteriorates and loan
defaults spike in the economic downturn.
There have to be signs of confidence in the economy, so
that banks [will] feel confident about lending and investment
demand picks up, Subbarao said.
Furthermore, interest rates offered to depositors remain
relatively high, which is reducing the flexibility of lenders
to reduce charges for loans.
Banks have offered retail depositors high interest rates as
they seek to maintain a more stable funding source, after the
spike in wholesale lending markets last year. Commercial banks
are also competing with government-backed saving schemes that
offer high interest rates, and risk-averse state banks are
investing excess liquidity in government rather than driving
Subbarao admitted that Indias fiscal stimulus package
comes at a cost. The cost is the fiscal deficit putting a
burden on discretionary public finance decision-making in the
future because of the burden of debt servicing, he said.
The other cost is, of course, our ability to wind this
down and return to a path of fiscal consolidation. Those are
the medium term concerns.
In the short term, the fiscal deficit is also undermining
Subbaraos attempts to reduce commercial interest rates.
The high fiscal deficit had raised yields in the market,
and that has to some extent militated against the low interest
rate regime we were looking at.
But he denied government borrowing is crowding out the private
sector. Weve pumped in so much liquidity that there
is enough money to take care of government borrowing as well as
private credit demand.
Rating agencies have warned that Indias high public debt
exacerbated by a fiscal stimulus package could
trigger a downgrade without timely consolidation of the public
However, the government argues India is being unfairly singled
out as the world embarks on a Keynesian style debt-financed
Montek Singh Ahluwalia, deputy chief of Indias planning
commission, told Emerging Markets
: I dont
think the ratings agencies really understood the changing
perceptions now in macro-economics, they are really reading
from last years rule-book.
This is the time when countries need to be injecting
demand into the system in the next two years but we will do
this in a framework that ensures medium-term fiscal
sustainability in a five-year horizon.