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Rate cartel: RBI must drop hint - Outside View by S.S. TARAPORE
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Rate cartel: RBI must drop hint
Feb 9, 2015

Governor Raghuram Rajan set out the Sixth Bi-Monthly Monetary Policy for 2014-15 on February 3, 2015. Since the Reserve Bank of India had taken policy action on January 15, 2015, it was expected that the policy statement would be a mere narration of the current situation. What has surprised all is that the Policy Statement is far-reaching and not only covers monetary policy, but also Development and Regulatory issues.

Monetary Policy

While the key policy repo rate at which the RBI provides liquidity to the banks against the collateral of government securities has been kept unchanged at 7.75 per cent, there are two changes which are noteworthy.

First, the statutory liquidity ratio (SLR) under which banks are required to maintain a minimum proportion of their liabilities in government securities has been lowered from 22 per cent to 21.5 per cent. The concern is that while the mandatory SLR has been reduced over time, the government's borrowing programme has been rising very sharply over the years. With a lower SLR and a rising borrowing programme, the RBI can be pressured to absorb more securities, which will generate more liquidity, which will put pressure on inflation. With the Union Budget on February 28, 2015, one strategy could have been to take a decision on the SLR after the Union Budget. The flip side of this is that by lowering the SLR before the Budget, it is a signal to the government to keep the borrowing programme within reasonable limits.

Second, a significant development is the closing of the Export Credit Refinance (ECF) facility. It has all along been known that sector specific refinance facilities attenuate the monetary transmission process. The recent Urjit Patel Committee had recommended that sector specific refinance facilities should be terminated and liquidity injection should be via the repo facility. The RBI has struggled for 25 years to break away from the ECF facility, but with the strong pressure groups, this has not been possible. The ECR is an inefficient way of supporting the export sector. The appropriate instrument is an appropriate exchange rate.

The present columnist and other eminent experts like Shankar Acharya and A.V.Rajwade have argued that the Indian rupee is over-valued and this is having a drag on export competitiveness . This is all the more relevant as micro, small and medium industry predominate in exports while large industry is import intensive. What is disconcerting is that in non-competing areas, imports have become competitive and are driving out the smaller Indian units. While the balance of payments current account deficit (CAD) for 2014-15 is estimated at 1.3 per cent of GDP, recent experience shows that the CAD can rapidly widen.

Since the RBI has clearly declared that it is committed to slowing down the inflation rate, it is gratifying to note that current indications are that the six per cent target for January 2016 will be met. It is important that a resurgence in inflation is not allowed to take place, especially as inflation hurts the weakest sections the most.

Development and regulatory measures

While the policy statement sets out a number of issues, there are three issues of concern to the common person.

First, individuals were allowed to take out of the country US $ 200,000 per annum. This was drastically reduced to US $ 75,000 in August 2013. In June 2014, it was raised to US $ 125,000.In a bold measure, the limit has been doubled to US $ 250,000.The liberal limit is unlikely to impact adversely on the balance of payments. In fact, a more liberal regime results in increased net inflows.

Second, the differential system of deposit interest rates is being tightened. At present, differential, interest rates can be prescribed by banks for deposits less than Rs one crore and deposits of Rs one crore and above. Deposits of less than Rs one crore by individuals and Hindu Undivided Families are callable i.e. they can be prematurely terminated. Under the new dispensation, to avoid asset liability maturity mismatches, a separate structure of interest rates is being prescribed, which will be non-callable. This will imply that the callable deposits will carry lower interest rates. This is unfortunate, as depositors are already suffering from low effective deposit rates given the inflation rate and this measure will worsen the position of depositors.

In June 2005, the RBI, in a benchmark circular, eased the procedures to enable easy transmission of deposits in the event of the death of a depositor. Under the extant instructions, premature encashment of deposits is permitted if all the depositors during their life time indicate that premature termination should be permitted. When setting out the detail instructions the RBI should specify that in the event of death of a depositor who holds non-callable deposits, premature termination should be permitted.

Third, there is an absence of any reference to the major problem on savings bank deposit interest rates. Since 2011 the rate was deregulated and each bank was to fix its own rate taking into account the cost of funds. All banks, other than a few small banks have cartelised the savings bank deposit rate at four per cent, the erstwhile regulated rate. This is an obvious case of cartelisation and action is called for.

A mere hint from the RBI should be enough to break the cartel. If the Jan Dhan scheme is to succeed, the cartel must be broken expeditiously.

Note: This article was first published in The Freepress Journal on February 09, 2015. Syndicated.

This column, Common Voice is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Hindu Business Line, is titled Maverick View.

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