RBI urges India’s banks to up lending

05/05/2009 | Taimur Ahmad, Sid Verma

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

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 India’s 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 India’s 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 Subbarao’s 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. “We’ve 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 India’s 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 India’s planning commission, told Emerging Markets: “I don’t think the ratings agencies really understood the changing perceptions now in macro-economics, they are really reading from last year’s 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.”

Related stories

  • Turnaround story Pakistan needs to keep up the pressure ...

    Pakistan has had an impressive year under new premier Nawaz Sharif. But the government needs to keep up its reforming zeal to get the South Asian state’s finances back on track.

  • World Bank to commit $2bn to Myanmar

    The World Bank’s East Asia chief, Axel van Trotsenburg, tells Emerging Markets why it is boosting its investment in Myanmar threefold.

  • MONGOLIA: OT mess holds up Mongolia's advance

    Falling commodity prices have hurt Mongolia’s economy, which relies heavily on its abundant natural resources. Improving relations with China are helping it through the squeeze but the country has yet to show its true potential to global investors

  • Europe must break policy taboos to escape stagnation ...

    Europe is stuck. On both monetary and fiscal policy, the continent is divided. Everyone likes structural reform - except voters. So creativity is called for. How about giving money to the poor?

  • LatAm bond party to go on in face of volatility

    Rising US interest rates should in theory lead investors to withdraw money from emerging economies so those in Latin America suffering weak growth. But leading debt bankers feel that the party has some time to go.

Editor's Picks

In Focus

  1. AFRICA IN THE INTERNATIONAL BOND MARKETS: African sovereigns go mainstream as investors shift focus away from Russia

  2. KAZAKHSTAN: Kicking Kazakhstan back into gear - Nazarbayev tries again at transformation