Stalling further shocks
By Shivaji Sarkar
The Reserve Bank of India has been sanguine in not changing the interest rates amidst clamour from depositors to raise it and the industry to reduce it. The Monetary Policy Committee meeting also noted that there might be some drop in the GDP growth because of disruption in money supply. At the same time, the Central bank lowered its growth forecast for 2016-17 to 7.1 per cent from 7.6 per cent. There are indications that it could further cut the projections.
All eyes were set on repo (repurchase) rate. The RBI left it unchanged at 6.5 per cent. It set at rest the speculation that banks could reduce consumer lending rates. It was certainly a shock for many, as the banks are full with Rs 11.85 lakh crore, almost 76 per cent of the scrapped currency deposits in the wake of demonetisation of high value notes. Many people thought that the flush of funds would be a great help for the banks suffering high NPA of almost Rs 12 lakh crore.
People forget that had those NPAs not been there, the banks would have been in a deluge. And flooding has its own problems, if not managed properly. The RBI finds that the banks themselves could not manage it, so even before the monetary policy announcement, banks were asked to maintain 100 per cent deposits accrued between September 16 and November 11 as incremental cash reserve ratio (CRR).
An increase in CRR means that the banks have to park more money with the Central bank. This sucks out liquidity from the banking system. And, the measure is to safeguard the deposits on which banks earn 6.25 per cent interest from the RBI, which prevents banks from pressure of managing excess funds.
The new situation is another aspect of the demonetisation. Those who believed that higher funds were equivalent to higher liquidity had not realised the risk factors. The credit demand is low as witnessed in October. It means that industry is either having excess funds or sluggish activities. The latter seems to be true as the industrial index has been indicating.
The strong action could also be aimed at signaling RBI’s reluctance on market interest rates falling too sharply, too soon in the present sluggish global context. The surplus rupee liquidity and sharply falling rates was also creating distortions in the forward premia and indirectly impacting the spot rupee-dollar rates. This liquidity absorption measure could partially reverse distortions.
Since mid-November, a number of banks have reduced deposit interest rates by almost one per cent. Some banks have done it a bit more. It leads to less yield on deposits, particularly term (fixed) deposits causing huge loss to all depositors and virtually gives a shock to senior citizens, women and other deprived people who depend on interest accruals.
It also needs to be understood that interest accrual is not an earning. It is only a safeguard against inflation and falling value of deposits. Bond yields could see knee-jerk reaction of around 15 basis points (bps) if rates had been cut. The issuing market stabilisation scheme (MSS) bonds of Rs 300 billion have been put off for this reason.
This indicates that the economy is passing through a fragile situation. If interest rates were allowed to fall further, it could have led to social tension, as the vulnerable depositors rue any fall in interest rates. The rate cut could have made loans cheaper, as per the general belief. But it is now also being said that lower interest rates leads to easy funding and even swindling of bank funds, opening these to the risk of high non-repayment or NPA.
The RBI though has not stated specifically, is now also considering that lower interests may not be in the interest of the economy and the health of the banks in the long run. There have been suggestions for minimum floor interest rates for deposits; mostly it is quoted at 9 per cent. So far the RBI has not accepted this.
The fixing of floor deposit rate is suggested as a safeguard against seekers of loans on frivolous reasons and ultimate swindlers. A higher deposit rate is also likely to repose faith in the banking system, which has been shaken by a number of large loan scams during 2009-2014.
The RBI stated that so far it could replenish Rs 4 lakh crore new currency— 25 per cent of the total demonetised assets. The four currency note presses at Nashik (Maharashtra), Dewas (MP), Salboni (West Bengal) and Mysuru (Karnataka) have the capacity to print about 26.66 billion pieces of notes in two shifts if they all work 24 hours. Thus, it may take may take six months to replenish the stocks. However, Finance Minister Arun Jaitley is optimistic and says the crisis would be over in three months.
The Government is not keen on printing the notes abroad to give a boost to indigenisation. Another reason is to prevent printing of fake notes. Earlier, it had done so and found that Pakistan too was printing its currency there. The presses are also facing some raw material shortage.
The problem has also been accentuated as the proportion of the Rs 100 note in circulation by volume has come down from 20.3 per cent in 2011-12 to 17.5 per cent by the end of 2015-16. During the same period, the proportion of Rs 500 note by volume increased from 14.8 per cent to 17.4 per cent. The proportion of Rs 1000 note also increased from 5 per cent in 2011-12 to 7 per cent in 2015-16. By the end of 2015-16, Rs 500 and Rs 1000 notes made up for a quarter of all the notes in circulation by volume, around 22 billion pieces.
Undoubtedly, the RBI is in a crisis management situation. Immediately it cannot correct the ratio because of market demand. It is, however, mulling how to increase the ratio of smaller denomination notes and reduce the supply of high value ones. It has already started the process by printing more Rs 50 and Rs 20 notes. But it would definitely take time to tide over the crisis.
Maintaining interest rates is the immediate step. The micro and macro financial management would take some time to correct many of the logistic anomalies. Overall, despite some reaction in the stock market, there is a broad agreement that the RBI has taken the correct step to save the economy from sudden shocks. —INFA