Central bank cites near-zero inflation rate, ample liquidity in system.
The Reserve Bank of India (RBI) On Tuesday said that banks should cut their lending interest rates further to support revival in investment demand, while referring to the near-zero inflation level and easy liquidity conditions in the system.
Despite some aggressive policy rate cuts by the central bank, commercial banks have not passed on their benefits to customers in the same measure.
RBI had reduced its lending rate (repo rate) by 400 basis points in the second half of 2008-09, but most banks lowered their lending rate in the range of 50-150 basis points only, it said.
State-owned banks have revised their Benchmark Prime Lending Rate (BPLR) downwards by 125-225 basis points, followed by 100-125 basis points by private sector banks and 100 basis points by five major foreign banks.
RBI said that, between October 2008 and mid-April 2009, public sector banks have reduced term deposit rates by 125-250 basis points, while private sector banks have reduced rates by 75-200 basis points and five major foreign banks have reduced it by 100-200 basis points. The reduction in deposit rates was more pronounced for deposits of up to three years’ maturity.
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Referring to price trends, RBI said that the inflation, as measured by the Wholesale Price Index (WPI), has fallen to near zero and is likely to get into negative territory. The current assessment is that the WPI inflation could be around 4.0 per cent by end-March 2010, RBI said. Also, with moderation in the Consumer Price Index-based inflation, inflationary risks have clearly abated.
Pointing to the current near-zero WPI inflation rate, RBI argued that real lending rates are still very high. The point-to-point variations in WPI exaggerate the level of real interest rate due to divergence between various price indices as also inflation expectations.
| MONEY MATTERS Reduction in deposit and lending rates (October 2008 - April 2009*) | |||
| Bank group | Deposit rates | Lending rates (BPLR) | |
| Public sector banks | 125-250 | 125-225 | |
| Private sector banks | 75-200 | 100-125 | |
| Five major foreign banks | 100-200 | 0-100 | |
| * As on April 18, 2009. | |||
| Monetary easing by the Reserve Bank since mid-September 2008 | |||
| Instrument | As at | Extent of Reduction | |
ratio @
Notwithstanding computational challenges, even when inflation is taken as 4.0-4.5 per cent based on the underlying trend, real lending rates would still appear to be high, the central bank said.
“Banks, therefore, must strive to reduce their lending rates further,” RBI added.
There is ample liquidity in the system. This is evident from the huge amounts that banks park with RBI under the reverse repo window. The daily average absorption at reverse repo window has been in excess of Rs 1,00,000 crore.
Given the cost plus pricing structure, banks have been slow in reducing their lending rates, citing high cost of deposits. RBI pointed out that the current deposit and lending rates are higher than what was prevailing in the 2004-07 period.
| CONSTRAINTS ON REDUCING RATES |
| In the course of discussions with RBI, banks have pointed out the following constraints in reducing rates: |
| * The administered interest rate structure of small savings acts as a floor to deposit interest rates |
| * While banks are allowed to offer ‘variable’ interest rates on longer-term deposits, depositors have a distinct preference for fixed interest rates on such deposits, which results in an asymmetric contractual relationship |
| * The intense competition for resources in the credit boom seen in 2004-07 pushed interest rate on wholesale deposits and increased cost of funds |
| * The linkage of concessional administered lending rates for agriculture and exports to banks’ BPLRs makes overall lending rates less flexible |
| * The persistence of large volumes of market borrowing by the government hardens interest rate expectations |
RBI also said that the reduction in deposit rates affects the cost only at the margin since existing term deposits continue at the originally contracted cost. Hence, lending rates take longer to adjust.
Judging from the experience of 2004-07, there is room for downward adjustment of deposit rates, it stressed.
Banks have indicated that a small savings rate acts as a floor to banks’ deposit interest rate. But that small savings and bank deposits are not perfect substitutes, RBI pointed out.
“Banks should not, therefore, be overly apprehensive about reducing deposit interest rates for fear of competition from small savings, especially as the overall systemic liquidity remains highly comfortable,” RBI said.