50-100 Bp Cut In Bank Rate Likely

The Reserve Bank of India is likely to cut the bank rate by 50 to 100 basis points in the forthcoming busy season credit policy to send a strong signal to the banking sector to further lower interest rates. The rationale behind the proposed cut seems to be that with the rate of inflation staying lower than anticipated, a bank rate cut can safely be implemented to spur slackening industrial growth.

Significantly, RBI governor C Rangarajan has been invited for the Prime Ministers meet with industry tomorrow, which is slated to discuss the current industrial slowdown. Sources reveal that the Reserve Bank is under pressure to take policy measures to increase the offtake of credit, specially now that the government has conveyed concern about the industrial recession.

 

The policy of low interest rates has paid off so far, with total funds flow from the scheduled commercial banks to the commercial sector increasing by Rs 3, 566 crore between March 28, 1997 and September 12, 1997, against a fall of Rs 4,027 crore in the corresponding period of the previous year.

This has also achieved another objective of the Reserve Bank to reduce the spreads of banks, thereby forcing them to increase operational efficiency. The rise in funds flow to the commercial sector has been mainly on account of investments by banks in commercial paper, bonds, debentures and preference shares of public sector undertakings and corporates.

Non-food credit fell by Rs 3,003 crore between March 28 and September 12, against a fall of Rs 5, 070 crore in the corresponding period of the previous year. However, investments in commercial paper in the current year up to

September 29 amounted to Rs 2,451 crore, against just Rs 182 crore in the corresponding period of 1996-97. Investments in bonds, debentures and preference share aggregated Rs 4,375 crore (Rs 886 crore).

The increase in investments in these two categories has substantially driven up the funds flow to the commercial sector. In fact, if last years decline of Rs 4,027 crore is taken into account, the turnaround in funds flow has amounted to Rs 7,593 crore.

The return on these assets are much lower for banks than on bank credit. In the case of commercial paper, interest rates are in the region of eight per cent to 11.5 per cent at present, against 11.3 to 12.5 per cent in April. This is much lower than the prime lending rate of banks (13.5 per cent), which will force banks to increase their operational efficiency to survive in the marketplace. Banking experts also point out that while we are probably nearing the end of the downward movement of the interest rate cycle, there appears to be a case for at least one more downward movement in the bank rate.

With the rate of inflation at the lowest level in a decade, real interest rates continue to be high. A prime lending rate of 13.5 per cent, along with a rate of inflation of about 4 per cent, means that the real interest rates are ruling at over nine per cent. These factors underlie the RBIs decision to opt for a bank rate cut.

Despite some indications to the contrary, the RBI will adhere to the traditional objectives of the monetary policy, namely, to maintain a reasonable degree of price stability and ensure adequate expansion in credit to assist growth. However, the relative emphasis on the two objectives may shift towards the latter objective.

RBI deputy governor Y V Reddy has pointed out, The relative emphasis between the two objectives depends upon the conditions prevailing in the year in question.

Experts within the RBI feel that with inflation currently under control, the balance is likely to shift to speeding up economic growth. This implies that an interest rate cut is in the offing.