Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Monetary Policy: A Thought for Depositors - Outside View by S.S. TARAPORE

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

Monetary Policy: A Thought for Depositors
Jun 15, 2015

Governor Raghuram G.Rajan set out the Reserve Bank of India's( RBI) Second Bi- monthly Monetary Policy Statement for 2015-16 on June 2,2015.The policy repo rate ( i.e. the rate at which the (RBI) provides liquidity against the collateral of government securities) was reduced from 7.5 per cent to 7.25 per cent. Since January 2015 the reduction in the repo rate amounts to 0.75 per cent. It is surprising that the cautious reduction of the policy rate brought forth a spate of protests and negative comments all around much more than when there was no reduction of the policy rate.

Rationale for RBI's Caution

The RBI sees a number of reasons for a cautionary monetary policy. First, there are concerns about the monsoon. While there are no doubt adequate stocks of wheat and rice to ensure against any undue rise in these prices, there could be increase in prices of coarse grains, pulses, oilseeds, vegetables, fruits, milk and poultry and the government has little ability to control these prices. As such there could be pressures on food inflation in the ensuing period. Secondly, there could be a resurgence in prices of crude oil. Thirdly, the overall global environment could impact adversely on inflation. Accordingly, the RBI has increased its inflation projection for January 2016 from 5.8 per cent set out in April 2015 to 6.0 per cent in the June 2, 2015 Review. The RBI assessment of the path of inflation is that it could decline till August 2015 but thereafter trend upwards.

The RBI's considered view is that the output growth in 2015-16 would now be 7.6 per cent as compared with 7.8 per cent at the time of the April 2015 Review.

Criticism of the RBI

Prior to the June 2, 2015 policy review by RBI, there was pressure from the cheer squads on the sidelines- government, industry, analysts and the media that there should be a substantial easing of monetary policy and in some quarters there was a call for a reduction of the RBI policy rate by as much as 1.5 percentage point. It seemed to be an article of faith that a reduction of RBI's policy rate would stimulate output by bringing about a change in sentiment.

It is amazing that lower interest rates are considered as a panacea for all the ills of the economy. If this were really so the global slowdown would have been easily tackled and the world would not be wallowing in a low level equilibrium trap. In any serious macroeconomic analysis it would be recognised that a mere reduction in interest rates would not resolve all the basic problems of an economy.

Adverse Impact of Too Large and Too Sudden A Reduction in Policy Interest Rates

Time and again it has been reiterated that a one percentage point reduction in lending rates of banks would result in a 0.2 percentage point reduction in industry which is credit intensive in the sense that interest cost accounts for 20 per cent of total costs. Thus, the argument that interest rate reduction would be a fillip to the economy is a canard. Let us hypothetically assume that the RBI had reduced its policy by 1.5 percentage points on June 2, 2015 and that the reduction would be fully transmitted to lending and deposit rates. This would imply that deposit rates would have fallen sharply from 8.5 per cent for one year to 7.0 per cent. Such a sharp reduction in deposit rates would have resulted in an exodus out of the stable term-deposits of banks and resulted in tremendous instability as banks would face a major asset-liability maturity mismatch and would need to cut back on credit and thereby nullify the very purpose of reducing interest rates.

Paramount Importance of Financial Inclusion

The government in no uncertain terms, has indicated that financial inclusion is a paramount objective of policy. In the recent period considerable efforts are being made by the government and other agencies to achieve effective financial inclusion. Thus, any policy or operation which militates against this objective needs to be rectified.

Cartelisation of the Savings Bank Deposit Rate Militates Against Financial Inclusion

The savings bank deposit rate was deregulated by the RBI in October 2011.The last regulated rate was 4 per cent. Barring a few banks which have offered different (higher) rates on these accounts, the bulk of scheduled commercial banks have continued to quote a rate of 4 per cent. The banks have been arguing that opening new Savings Bank accounts as part of financial inclusion involves a very high cost. The bulk of deposits raised in the rural areas are in the form of Savings Bank accounts and most of these deposits are very stable. Banks are required to balance their cost of funds and the return on funds. It is curious that by this test it would appear that the cost of funds for all banks (other than the very few who quote higher rates) is identical. There is no alias for this other than to call it a case of blatant cartelisaion. How does the cartel work? There is surely no written document but there must be a tacit understanding.

Yet the Competition Commission does not act on this matter, neither does the government nor the RBI. Even depositors associations do not lead a depositors' revolt. The banks running the cartel meanwhile sit with supreme complacency. Looks like the entire Indian polity believes in the Thrasymachus principle: "Justice is the interest of the stronger" which is debated in Plato's Republic but demolished by Socrates. I've shed my tears.

Please Note: This article was first published in The Freepress Journal on June 15, 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.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Monetary Policy: A Thought for Depositors". Click here!


More Views on News

Two Meetings That Nailed the Idea of Owning Brilliant Smallcaps Without Buying Them (The 5 Minute Wrapup)

Mar 22, 2018

Certain blue chips hold the potential of delivering returns comparable to small-cap stocks. With these stocks, you can get the best of both worlds.

What They Forgot to Tell You About Sensex at One Lakh (Profit Hunter)

Nov 29, 2017

Stocks that could beat Sensex returns in the long term.

How I Got My Wife To Invest In Mutual Funds... (Outside View)

Jul 20, 2018

PersonalFN brings to you a real-life case of how husband and wife engaged in a sensible money-talk post-marriage to build a solid mutual fund portfolio.

Our Newest "Fixer-Upper" (Vivek Kaul's Diary)

Jul 20, 2018

Bill Bonner talks in detail about US president been accused of treason, biggest debt default in China, the problem of growing inflation and the trade war.

The 'Profitable' Ola and Uber You Can lnvest In Right Now (Profit Hunter)

Jul 20, 2018

Here's is a business in small cap space that is asset-light and yet profitable - A serious contender for the list of future blue chips.

More Views on News

Most Popular

How to Avoid a 90% Loss Suffered by This Super Investor(The 5 Minute Wrapup)

Jul 12, 2018

Blindly following super investors is a dangerous game to play. Here's how you can avoid such mistakes.

The Answer to Your Wealth Worries: Small Caps (Especially Now)(Profit Hunter)

Jul 10, 2018

If you're worried about the markets - you are on the wrong track. This is opportunity - put your wealth-building hat on, instead - Richa shows you how...

The Multiple Problems with the Minimum Support Price (MSP) System(Vivek Kaul's Diary)

Jul 11, 2018

The price signals that MSP sends out, creates its own set of problems.

ICICI Pru Mutual Fund Tarakki Karega! - The Unethical Way?(Outside View)

Jul 11, 2018

PersonalFN explains how ICICI Prudential Mutual Fund flouted the norms of related party transactions while subscribing to the IPO of ICICI Securities.

PPF v/s Mutual Funds: Which Is Better?(Outside View)

Jul 10, 2018

PersonalFN highlights the key points of distinction between PPF and mutual funds.


Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms


Jul 20, 2018 (Close)