New Monetary and Credit Policy (2009-10)

The Reserve Bank of India (RBI) in its Annual Monetary and Credit Policy for 2009-10, released on April 21, 2009, slashed the Repo and Reverse Repo Rate by 25 basis points each. This could result in home and auto loans becoming cheaper. The RBI reduced the Repo Rate to 4.75 per cent and Reverse Repo to 3.25 per cent with immediate effect, while retaining other key rates like the cash reserve ratio, the percentage of deposits that banks keep with the central bank.

Banks have the apprehension that reducing deposit rate could shift deposits to post office saving instruments, which for some banks are not valid, while for some it is, the policy stated. In the wake of RBI policy cut, bankers have hinted that there could be reduction in lending as well as deposit rates.It is a signal to bankers to cut rates. Interest rate has already come down and it should soften further.

Since mid-September 2008, the RBI has cut the Repo Rate by 400 basis points and the Reverse Repo Rate by 250 basis points. The Cash Reserve Ratio (CRR) was also reduced by 400 basis points.

Support to Stabilize Economy
The RBI noted that its efforts under the monetary policy in 2009-10 would be to ensure a policy regime that enables credit expansion at viable rates while preserving credit quality so as to support the return of the economy to a high growth path.

The apex bank noted that India too has suffered the impact of the global financial crisis to degree far higher than expected. The extent of impact has caused dismay, mainly on two grounds: first, because our financial sector remains healthy, has had no direct exposure to tainted assets and its off-balance sheet activities have been limited; and second, because India’s merchandise exports, at less than 15 per cent of the GDP, are relatively modest, the RBI stated.

The RBI noted that the immediate challenges before it included supporting the drivers of aggregate demand to enable the economy to return to its high growth path, boosting the flow of credit to all productive sectors of the economy, ensuring an orderly withdrawal of the large liquidity injected in the system since September 2008 by the RBI to support the economy's productive requirements; and the continued challenge of preserving the stability of our financial system drawing from the lesson of the global crisis.

Foreign Banks Policy
The RBI in its policy stated that it would not hurry with the proposal to liberalise operation of foreign banks in the country in the wake of the global financial meltdown. The existing policy would continue, RBI stated.

Growth Rate
The RBI policy also forecast the Gross Domestic Product (GDP) growth at six per cent for the financial year 2009-10, while the rate of inflation was seen at four per cent by March-end. The regulator also projected credit growth and deposit growth at 20 per cent and 18 per cent, respectively.

Deposit and Lending Rates
Following several cuts in key policy rates by RBI, all public sector banks, most private sector banks and some foreign banks have reduced their deposit and lending rates. The reduction in the range of term deposit rates between October 2008 and April 18, 2009 has been 125-250 basis points by public sector banks, 75-200 basis points by private sector banks and 100-200 basis points by five major foreign banks. The reduction in the range of BPLRs was 125-225 basis points by public sector banks, followed by 100-125 basis points by private sector banks and 100 basis points by five major foreign banks.

However, these reductions in lending rates have not spurred lending activities. In fact, during 2008-09, the growth in non-food bank credit (year-on-year basis) decelerated from a peak of 29.4 per cent in October 2008 to 17.5 per cent by March 2009.Substantially lower credit expansion by private and foreign banks also muted the overall flow of bank credit during the year, the policy stated. Given the wide dispersion of credit growth noticed across bank groups during 2008-09, banks with strong deposit base should endeavour to expand credit beyond 20 per cent.

Benefits for Interest on SB Accounts In another move that could boost small savings in the country, the RBI has proposed that the payment of interest on saving bank accounts by scheduled commercial banks be calculated on daily basis.

At present, interest on saving bank accounts is calculated on the minimum balances held in the accounts during the period from the 10th day to the last day of each calendar month.It is proposed that payment of interest on saving bank accounts by scheduled commercial banks would be calculated on a daily basis with effect from April 1, 2010, RBI stated in the annual policy statement 2008-09. This would mean depositors would earn interest on all the 30 days on a daily basis.Several banks have suggested that interest rate on savings bank accounts may be either calculated on minimum balances in deposit accounts during the period from first to last day of each calendar month or on a daily basis.

Opening ATMs without Approval

After allowing customers of free usage across all ATMs, the RBI has now allowed banks to set up offsite ATMs without prior approval. It is proposed to allow scheduled commercial banks to set up offsite ATMs without prior approval subject to reporting, the credit policy stated. These moves could help customer make more use of ATM services.Earlier, the RBI allowed customers to withdraw cash from any ATM without any charge irrespective of the fact whether they hold ATM of that bank. Banks will not levy any fee on cash withdrawals using ATM and debit cards issued by their counterparts.

The RBI also proposed to constitute a group to review the framework of branch authorization policy with a view to providing greater flexibility, enhanced penetration and competitive efficiency consistent with financial stability.

Assessment
The RBI’s approach has been to watch and wait and nudge banks towards reducing their rates rather than aggressively cutting rates. If in response to this policy move, banks do move and cut rates, the RBI should cut rates further in the coming weeks. It should also cut the CRR, which is a tax on the banking system and needs to be removed, especially at a time when bank balance sheets are going to be under stress.

In fact, the reduction in the short-term lending rate by the RBI in as many months is accompanied by widespread pessimism that it is not percolating to the end user. The repo rate, at which the central bank lends overnight money to banks, at 4.75 per cent is now half of what it was in October 2008. The increased liquidity is being used by risk-averse banks to lend mainly to their most credit-worthy borrower: the government. Since October 2008 growth in bank lending to companies and individuals has slowed from 15 per cent to three per cent in March 2009.

The expansionary fiscal policy is likely to result in a GDP growth rate of six per cent in the year to March 2010. The first officially articulated projection, in the RBI’s annual policy statement, is justifiably cautious. It should come as some comfort that Mint Road has not had to look for options beyond interest rates at this stage of the game.