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Reforms march ahead-II - Views on News from Equitymaster
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  • Aug 29, 2003

    Reforms march ahead-II

    In the prelude to this article, we had illustrated that despite elections being around the corner, the government has been going ahead with its implementation of the reforms process. What is heartening is that elections have not dampened the resolve of the government. In this light the RBIís reduction in the repo rate will be of further help to the economy.

    ĎRepoí rate stands for repurchase options, and are basically short-term debt instruments that the RBI issues to adjust liquidity in the markets. While the intention of the RBI is clear, vis-ŗ-vis soft interest rate regime, the proactiveness of the Central Bank is paramount. While the reduction of the repo rate may not be a reform as such, the intention is very clear from the RBIís side. The intention is to spur growth by making capital cheaper. While this has worked to an extent, higher credit offtake seems to have been restricted to a few sectors.

    The effect of the reduction in repo rates has had an almost immediate impact on the banking sector. One of the largest public sector banks in the country has already pared its deposit rates, while others have indicated that in view of the new developments, they are open to the idea of paring down both lending as well as deposit rates. This will have a couple of benefits for the economy as a whole. Firstly, banks at a latter stage will be forced to review their Prime Lending Rates (PLRs). This means that corporates who did not have access to cheap sources of capital will now have an option.

    While it may be a while before PLRs are aligned to interest rates prevailing in the market, the repo rate cut is a step in the right direction. Currently, apart from companies that have strong credit ratings, the remaining are not in a position to borrow at a rate below PLR. Under these circumstances, there is need to rationalise PLRs further, that too downwards. In an earlier article, we had indicated that borrowers in the country continue to pay a high real rate of interest despite falling lending rates.

    The second indirect benefit that this move is likely to bring about is that as deposit rates head southwards and with the public savings schemes being aligned (though this will take more time) to market rates, investors would look for other options that give better returns. Retail investors, for example, may chose to invest more money in the stock markets, either directly or via the mutual fund route.

    While the Indian financial system has a long way to go as far as reforms are concerned, we can safely say that the efforts to reach there are well under way. In this respect, full marks to the governmentís intention and the RBIís proactiveness. As the country slowly but surely gets integrated with the global economy, further reforms are a necessity. For once, populist measures seem to be taking a back seat to the reforms process. We hope that this continues in the future, irrespective of who comes to power.



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