RBI Watch Monetary Policy 2015-16
The monetary policy cycle for the new financial year , 2015-16, has started with no change in the monetary policy stance of the RBI.
A quick recap on monetary policy in the last financial year, 2014-15: RBI started the year with the policy repo rate at 8%, then moved it lower in two steps ( between scheduled bi-monthly statements) to 7.5% in January and March; RBI reduced the SLR in small steps (0.5% each time) in June, August and December to 21.5%.
The real story of this start to the year is the extreme unhappiness of the RBI at the unwillingness of banks to reduce their lending rates despite the reduction in the repo rate by the RBI - an accommodating move that arguably started even earlier with the reduction in the statutory liquidity ratio (SLR) of banks. So much so that Rajan has stated that a key factor in the next interest rate move (presumably downwards) will be the extent of the follow through by banks to reduce their lending rates.
I had in my first blog on monetary policy on April 16 last year devoted a section to this issue titled "Transmission of Monetary Policy to lending rates is a problem" . Later in my blog of December 31 last year, I concluded that given the liquidity position of banks then, they could reduce lending rates without waiting for the RBI to reduce the policy rate. I suggest a reading of both these blogs.
Now things have really come to a head between the RBI and the banks. Rajan has announced that banks will soon need to move to a marginal-cost-of-funds- based determination of the base rate, the benchmark minimum lending rate of banks.
I believe this is the wrong move. RBI should not end up unwittingly micromanaging the pricing of loans and deposits. India's banks are by and large well run, and some of them are world class. Base rates based on the average cost of funds make as much sense as their determination by the marginal cost of funds. Banks as commercial enterprises should be free to determine their approach to pricing loans and deposits. The important point should be that pricing must be consistent, transparent, and fair. Consistency, and transparency would enable customers to make the best decisions in their interest, and fairness would make it equitable, both in terms of large and small customers and new and old customers of the banks.
Instead, RBI needs to hasten the pace of development of deeper money and bond markets. This will make accessing bank loans and the markets equally attractive for customers, and force banks to be more responsive. Also, RBI needs to continue to reduce the mandatory investment in government securities by banks by reducing the SLR still further and in bigger steps.
Note, in another move that was initiated last year by the RBI, Financial Benchmarks India Private Ltd, has been set up, and will become operational soon. The idea is that this enterprise will develop independent benchmarks to facilitate the pricing of deposits and loans, and RBI will encourage banks to use these benchmarks.
Finally, a word on the path of inflation this year. From RBI's point of view, inflation will further fall to as low as 4% by August, but then rise to close to 6% by end of the year. RBI's message is clear to my mind: transitory falls in inflation will not warrant a further reduction in the policy repo rate. So expect a cut in the repo rate only if inflation falls unexpectedly and on a sustained basis below 4% after August.
The monetary policy cycle for the new financial year , 2015-16, has started with no change in the monetary policy stance of the RBI.
A quick recap on monetary policy in the last financial year, 2014-15: RBI started the year with the policy repo rate at 8%, then moved it lower in two steps ( between scheduled bi-monthly statements) to 7.5% in January and March; RBI reduced the SLR in small steps (0.5% each time) in June, August and December to 21.5%.
The real story of this start to the year is the extreme unhappiness of the RBI at the unwillingness of banks to reduce their lending rates despite the reduction in the repo rate by the RBI - an accommodating move that arguably started even earlier with the reduction in the statutory liquidity ratio (SLR) of banks. So much so that Rajan has stated that a key factor in the next interest rate move (presumably downwards) will be the extent of the follow through by banks to reduce their lending rates.
I had in my first blog on monetary policy on April 16 last year devoted a section to this issue titled "Transmission of Monetary Policy to lending rates is a problem" . Later in my blog of December 31 last year, I concluded that given the liquidity position of banks then, they could reduce lending rates without waiting for the RBI to reduce the policy rate. I suggest a reading of both these blogs.
Now things have really come to a head between the RBI and the banks. Rajan has announced that banks will soon need to move to a marginal-cost-of-funds- based determination of the base rate, the benchmark minimum lending rate of banks.
I believe this is the wrong move. RBI should not end up unwittingly micromanaging the pricing of loans and deposits. India's banks are by and large well run, and some of them are world class. Base rates based on the average cost of funds make as much sense as their determination by the marginal cost of funds. Banks as commercial enterprises should be free to determine their approach to pricing loans and deposits. The important point should be that pricing must be consistent, transparent, and fair. Consistency, and transparency would enable customers to make the best decisions in their interest, and fairness would make it equitable, both in terms of large and small customers and new and old customers of the banks.
Instead, RBI needs to hasten the pace of development of deeper money and bond markets. This will make accessing bank loans and the markets equally attractive for customers, and force banks to be more responsive. Also, RBI needs to continue to reduce the mandatory investment in government securities by banks by reducing the SLR still further and in bigger steps.
Note, in another move that was initiated last year by the RBI, Financial Benchmarks India Private Ltd, has been set up, and will become operational soon. The idea is that this enterprise will develop independent benchmarks to facilitate the pricing of deposits and loans, and RBI will encourage banks to use these benchmarks.
Finally, a word on the path of inflation this year. From RBI's point of view, inflation will further fall to as low as 4% by August, but then rise to close to 6% by end of the year. RBI's message is clear to my mind: transitory falls in inflation will not warrant a further reduction in the policy repo rate. So expect a cut in the repo rate only if inflation falls unexpectedly and on a sustained basis below 4% after August.
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