Managing hopes
16 Jan 2015 10:23 PM GMT
As we enter the harvest season, the Reserve Bank of India has reduced the rate at which it lends money to commercial banks by 25 basis points from 8 per cent to 7.75 per cent. Although many in the government and industry have hailed the move, RBI Governor Raghuram Rajan’s decision to reduce lending rates must not generate undue excitement. For months, members of government and industry have been pushing Rajan to reduce lending rates to induce a greater infusion of capital into the economy.Â
Allied with a steep reduction in crude oil prices from more than $100 a barrel in June 2014 to under $50 this month and falling inflation figures, many expected Rajan to reduce lending rates sooner. Until last month, the RBI Governor remained adamant, stating that the central bank needed more time to gauge whether the government was serious about facilitating structural changes to address grave fiscal concerns and whether the fall in crude oil prices and inflation was here to stay. In his December monetary policy review, however, Rajan said that he could consider a rate cut ‘outside the policy review cycle’, as long as inflation figures and steps to reduce fiscal deficit were encouraging. The significant fall in crude oil prices has tremendously reduced the government’s import expenses, thereby improving its fiscal situation.Â
A statement on the RBI’s website on Thursday, which announced the reduction in lending rates, stated that developments over the last few months have ‘provided (adequate) headroom for a shift in the monetary policy stance’. This is all the central bank has said. There is a belief, mistakenly circulated, that the country’s central bank policy rate is the one decisive factor affecting the country’s credit scenario. However, we must remember that excessive presence of slippages that banks have to face can considerably reduce the effectiveness of policy rate cuts.
In other words, banks may not be able to pass on the entire lending rate reduction benefit to their borrowers in the market. In lieu of such circumstances, the reaction from the government and companies on the stock exchange has been nothing short of excessive, although there are expectations that the RBI may further reduce lending rates. These expectations, however, are based upon the fact that crude oil prices will not rebound any time soon. With global geo-political scenarios changing all the time, nothing can be gauged with absolute certainty.
Allied with a steep reduction in crude oil prices from more than $100 a barrel in June 2014 to under $50 this month and falling inflation figures, many expected Rajan to reduce lending rates sooner. Until last month, the RBI Governor remained adamant, stating that the central bank needed more time to gauge whether the government was serious about facilitating structural changes to address grave fiscal concerns and whether the fall in crude oil prices and inflation was here to stay. In his December monetary policy review, however, Rajan said that he could consider a rate cut ‘outside the policy review cycle’, as long as inflation figures and steps to reduce fiscal deficit were encouraging. The significant fall in crude oil prices has tremendously reduced the government’s import expenses, thereby improving its fiscal situation.Â
A statement on the RBI’s website on Thursday, which announced the reduction in lending rates, stated that developments over the last few months have ‘provided (adequate) headroom for a shift in the monetary policy stance’. This is all the central bank has said. There is a belief, mistakenly circulated, that the country’s central bank policy rate is the one decisive factor affecting the country’s credit scenario. However, we must remember that excessive presence of slippages that banks have to face can considerably reduce the effectiveness of policy rate cuts.
In other words, banks may not be able to pass on the entire lending rate reduction benefit to their borrowers in the market. In lieu of such circumstances, the reaction from the government and companies on the stock exchange has been nothing short of excessive, although there are expectations that the RBI may further reduce lending rates. These expectations, however, are based upon the fact that crude oil prices will not rebound any time soon. With global geo-political scenarios changing all the time, nothing can be gauged with absolute certainty.
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