Rangarajan urges it to act on inflation.
The Reserve Bank of India (RBI) favours giving banks the freedom to decide interest rates on their savings deposits, according to deputy governor K C Chakrabarty.
A decision on this would be taken after discussions between all the stakeholders — banks, depositors and regulators. RBI sets the interest rate on savings accounts and it is currently 3.5 per cent.
The proposal to free savings rates was supported by C Rangarajan, a former RBI governor and now chairman of the Prime Minister’s Economic Advisory Council. He also sounded a cautionary note that inflation had accelerated to an ‘uncomfortable level’ and that some RBI action on the demand side was called for.
The two were speaking at a meeting here on the issue of ‘financial deepening’. The deputy governor concurred that inflation was a cause for concern. However, he stopped short of saying when and what action the RBI could take. The government on Monday said inflation in May rose to 10.16 per cent. It had also revised upwards to double-digits the inflation figures for February and March.
“Double-digit inflation is not an easy thing,” said Chakrabarty. “The international situation is not that volatile. Something has happened in Europe. It has not happened in the United States. It has some adverse implications. I think, more than that, the domestic inflation is definitely a matter of worry.”
Over recent months, RBI has initiated steps to counter inflation. It raised key rates by quarter percentage points each on March 19 and April 20, lifting the repo rate to 5.25 per cent and reverse repo to 3.75 per cent. Bond traders and analysts have been speculating if the RBI will raise rates a third time and before its scheduled monetary policy review meeting on July 27.
“The double-digit inflation has now remained for three to four months. Therefore, it can no longer be treated as purely food inflation because the manufacturing sector is also showing a reasonably high degree of inflation, at 6 per cent-plus,” said Rangarajan. “Some action on the demand side is called for. It’s up to the Reserve Bank to take action, whether immediately or a little later. But, I think the question of taking some action in terms of tightening the policy has become imperative.”
Both issues linked
To ensure smooth transmission of its monetary policy, RBI last year suggested interest rates on savings deposits must be left to banks to decide. It began by asking banks to calculate savings bank interest rates on a daily basis from April 1 this year. Earlier, banks calculated this rate for the last 20 days of the month. As daily calculation increased the cost for banks, the bankers had demanded a cut in the savings bank interest rate.
The central bank’s move to free the savings rate is also aimed at smooth transmission of monetary policy in bank interest rates. It was observed by the regulator (in April 2009)that interest rate responses by banks to monetary policy changes were sticky during the period when RBI aggressively reduced interest rates after the onset of global financial crisis from September 2008.
In that same April 2009 policy statement, RBI said adjustment in market interest rates in response to changes in policy rates get reflected with some lag. Transmission to the credit market is somewhat slow on account of several structural rigidities,it said. The administered interest rate structure of small savings acts as a floor to deposit interest rates, banks told RBI. Without reduction in deposit rates, banks find it difficult to reduce lending rates exclusively on policy cues, RBI said.
Govt on board
Though RBI had mooted freeing savings bank interest rates in April 2009, the government didn’t seem comfortable with it, as small savers, including pensioners, would have suffered if savings bank rates declined. However, the central bank indicated the government was now in agreement.
“Deregulation is not Reserve Bank policy. Deregulation comes under reform in the financial sector,” said Chakrabarty. “It has been approved by the parliament. This is (a)sequence of the reform.”
Supporting the RBI view, Rangarajan said, “I think the direction in which the thinking is going is that the savings deposit rate also should be free. It is only a matter of timing. Some modifications can also be introduced -- like, if a minimum can be prescribed.”
Both Chakrabarty and Rangarajan said competition will ensure rates don’t vary by a large margin and ruled out high variation in savings rate of banks in a deregulated environment.
In its April 2009 statement, RBI also proposed to re-visit the benchmark prime lending rate of banks in order to bring transparency in loan pricing and smoothening monetary policy transmission.
Consequently, it decided to replace the benchmark prime lending rate by the Base Rate, in which banks have been given freedom to decide the methodology on calculating it, but barred from lending below this rate. Under the present system of benchmark prime lending rates, almost up to 70 per cent of loans are given below the prime rate. The base rate regime will take effect from July 1.
