RBI nudges banks to cut rates

More measures to curb capital inflows likely.

Banks are expected to review their deposit and lending rates in April on prodding by the Reserve Bank of India (RBI) even as the monetary policy today kept key policy rates unchanged owing to continuing inflation concerns.

In its quarterly review of monetary policy, RBI said banks have enough room to lower deposit and lending rates, given the fact that their net interest margins (NIMs) are "very high", even by international standards, and that they are flush with liquidity amid slowing credit demand.

Bankers took the cue and said there are sufficient indications in the policy that interest rates on both deposits and advances could be reviewed in the next quarter.

"There could be a realignment of interest rates within the existing structure. The entire system would take a view," said M B N Rao, chairman of Canara Bank, India's third largest bank by assets.

Despite bankers sensing room to reduce rates at least by about 25 basis points, most want to wait for the current financial year to be over to take a view.

Competitive pressure is also holding back banks from reducing high deposit rates. Public sector banks need to maintain the pace of deposit accretion to help them boost their business (credit plus deposit) growth to meet the current year's targets.

RBI's decision to hold repo and reverse repo rates, respectively the rates at which it lends to banks and borrows from them against short-term money against government securities, at 7.75 per cent and 6 per cent was driven by inflationary concerns outweighing emphasis on growth, which was considered in line with expectations.

The Bombay Stock Exchange Sensitive Index fell marginally and bonds pared earlier gains made on speculation the bank would cut rates.

Reddy's decision reflects concerns that rising oil and food prices will fuel inflation, which is now below the bank's target for the year, following seven increases in the repurchase rate since 2005.

In his quarterly review of monetary policy, RBI Governor YV Reddy hinted at further policy measures to curb capital inflows and reduce the impact of already intensified risks to inflation from oil, food and metal prices and also liquidity infusions by central banks in the developed countries to keep their financial markets floating.

The policy aims to contain inflation close to 5 per cent in 2007-08.

The inflows, which the central bank says have grown stronger in 2008, resulted in money supply growth of 22.4 per cent and RBI's endeavour is to pull it back to its target of 17 to 17.5 per cent for 2007-08.

Describing the monetary policy as "standstill", Finance Minister P Chidambaram said the central bank has the flexibility to move either way depending on international developments and liquidity situation within the country.

He added that the government would work closely with the central bank to respond to any emerging economic situation that could impact prices.

RBI now also wants banks to make institutional and procedural changes to enhance credit delivery to sectors that are employment-intensive, having added credit delivery to the overall stance of the monetary policy along with credit quality.

Maintaining a GDP growth projection of 8.5 per cent in 2007-08, the central bank said the government needs to examine whether slowing growth in the industrial sector to 9.2 per cent during April-November 2007 from 10.9 per cent a year earlier reflected correction of the excesses in the previous years or whether there are sector-specific factors which require attention.

The RBI also highlighted the risks associated with international financial developments impacting balance sheets of companies with sizeable external liabilities and urged banks to review large foreign currency exposures and to put in place a system for monitoring such unhedged exposures.

Banks have also been asked to set board-approved limits on foreign currency loans and to "carefully" monitor companies' treasury activities and their sources of other income.

A M Naik, chairman of L&T, said any restrictions on foreign currency loans would hit large projects as companies generally go for these loans to reduce borrowing costs and achieve financial viability.

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WHAT THE POLICY SAID

Developments in domestic economy broadly in line with expectations; do not warrant any significant monetary policy initiative now

Risks to inflation from high and volatile international prices of fuel, food and metals have intensified

Banks expected to lower deposit and lending rates

...AND WHY

RBI had targeted 8.5 per cent growth for 2007-08; moderated from 9 per cent target a year ago

RBI expects potential capacity in the economy to increase in the next 12 to18 months; will be far more comfortable if more demand is generated later than now;

RBI wants banks to be more pro-active in extending credit; would like to look into the way credit is being expanded and the terms of credit

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