Last week, the finance ministry announced that it was working out a plan to re-capitalise public sector banks, so that they could offer loans at lower rates to select borrowers, particularly in the retail segment. This was expected to boost demand for products such as two-wheelers in time for the festival season, bringing a bit of cheer in an otherwise largely gloomy environment. It was striking that this announcement came after a meeting between the finance minister and the governor of the Reserve Bank of India (RBI), implying that it had the latter's endorsement. If this is the case, then, between the mid-quarter review of September 20, in which the RBI announced a tightening of the monetary policy stance, and last week, its position appears to have changed. If not, it needs to provide some explanation for how stimulating demand for even some products is consistent with its anti-inflationary stance. Or, is this just another instance of monetary policy being hijacked by a finance ministry seeking to smooth over ruffled feathers in the business community?
The fact is that public sector banks need additional capital to enable them to sustain growth over the medium and long term. To the extent that the current situation is not very conducive to generating internal resources, because of both sluggish demand for loans and deteriorating asset quality, they need to access it externally. Either the government provides it, for which it has made an allowance in the Budget, or funds are mobilised from the market. But this process should have nothing to do with what rates the banks currently lend at; that decision should depend on liquidity conditions and, most importantly, the monetary policy stance. In short, the decision to provide additional capital at this time certainly has its merits, but the explicit linkage between this and interest rate actions - that too selectively - smacks of not just unwarranted control over banks but also undue interference in the monetary policy transmission process.
These are not the only concerns about the plan. Reservations have already been expressed by RBI Deputy Governor K C Chakrabarty. His concerns highlight the risk implications of drawing in a new set of borrowers with lower rates, only to subject them to rate hikes later, assuming the monetary situation remains tight. This could be a trigger for increasing default among retail borrowers. Responses from potential beneficiaries in the manufacturing sector are also somewhat lukewarm, suggesting that lower financing costs are not going to provide a significant boost to demand. This is particularly the case if the lower rates are seen as being temporary. Beyond this, there is the fundamental issue of unfair competition. Putting all other concerns aside, if public sector banks are to use the capital infusion to target specific market segments, it could be viewed as a cause for action by private banks under competition law. All in all, the plan as it has been reported upon appears to have a number of downsides without any significant upsides, apart from appeasement of some constituencies. The biggest downside is likely to be the re-emergence of the perception that monetary policy is being made more in North Block than at Mint Road.
