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 loan growth.
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 finances.
However, the government argues India is being unfairly singled out as the world embarks on a Keynesian style debt-financed fiscal stimulus.
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.