Don’t miss the latest developments in business and finance.

Security vs growth

Image
Business Standard New Delhi
Last Updated : Jun 14 2013 | 5:03 PM IST
The finance minister's meeting with the heads of public sector banks has resulted in two clear findings: interest rates are set to climb further as liquidity tightens, but the Reserve Bank has some policy cushions to soften the blow on borrowers. The action therefore shifts to Mint Road, where the RBI governor has already indicated that the liquidity problem is "frictional". In other words, it can be addressed quite easily, and does not require "structural" changes. The demand has already been raised that the RBI should accelerate the winding down of the market stabilisation scheme""thus pumping more liquidity into the system. The governor has said he is already pumping in money through repo auctions; the question is whether he needs to go further and lower the statutory liquidity and cash reserve ratios, so that banks have more money to lend to commercial customers. Both steps should certainly be considered, when the governor makes his next credit policy announcement next month.
 
The difficulty with keeping rates low is that they are rising internationally. With the US Federal Reserve set to raise rates once again, the governor would obviously want to prevent money flowing out of the country in search of greener pastures, just when the current account deficit has ballooned to 3 per cent of GDP and the country is therefore in need of capital inflows. The RBI's other concern has been rising asset prices, driven on the stock market by investment flows from abroad, and in the real estate market by people moving cash earned on shares into houses and flats. This too suggests that interest rates should be raised. However, the fact that companies are furiously borrowing abroad suggests that overseas interest rates for reputed corporate customers are lower than within the country. This should make Indian banks revisit their own strategy of jacking up rates, and review the spreads that they are now getting between their borrowing and lending rates.
 
In a situation with contrary pulls and pressures, the RBI's primary concern will be with wanting to prevent a macro-economic problem down the road, and it will not worry overmuch about a 1 per cent slowdown in economic growth, if that is the price to be paid. For, one thing is clear: if interest rates rise much further than they already have, the housing and automobile markets (driven as they are by cheap credit) will be cooled down. Companies drawing on debt to finance investments will also re-visit their numbers with regard to the return on the investment. As against this, the finance minister's concern with sustaining rapid growth is clear to everyone. In his Budget, he has opened the tap on liquidity by giving more room for foreign institutional investors to enter the domestic debt market, for government as well as corporate paper. He has also increased the overall limits for overseas borrowing by companies. These measures are understandable and facilitate the capital inflows that are needed. However, they also add to the country's overseas debt numbers, and will impact decisions by rating agencies""which in turn will raise the cost of borrowing abroad.

 
 

Also Read

First Published: Mar 27 2006 | 12:00 AM IST

Next Story