RBI’s stance during its third quarter review of its 2008-09 monetary policy, although on expected lines, was more conservative than the approach we had earlier argued. All major policy rates have been left unchanged and little by way of fresh measures for refinance and additional credit lines added. Although a deepening slowdown (and probably worsening economic conditions) is acknowledged in the downward revision of the GDP growth rate to 7% or lower, it is clear that RBI would like to wait to see the effects of the earlier aggressive easing on the intended final and intermediate economic targets.
The primary focus of all policy initiatives, monetary, fiscal and others, for the past few months has been to infuse liquidity into the system and to stimulate economic activity, both consumption and investment. The former set of measures has apparently worked, and we are waiting to get some clarity on the latter. But one aspect of the intended response has not worked quite as expected. This is a stickiness in the delivery of bank credit to productive economic activities. As indeed the statement goes to pains to emphasise: “The transmission of the policy interest rate signal has been effective in the money and government securities market. However, the transmission in the credit market has so far been subdued”. The focus of policy is now quite clearly to increase credit flows, principally through banking channels.
Unfortunately, bank credit delivery at “reasonable” rates involves multiple complex facets. The two most important issues are (i) access of banks to low cost funds, and (ii) more critically, an amelioration of the perceived credit risk environment that banks face when extending credit to borrowers. Why should we argue for further lowering the costs of funds for banks through deeper rate cuts, given that LAF reverse repo liquidity has remained quite high? One reason that this has not been much comfort to banks is apparently that this liquidity has been concentrated with a few banks; other banks which are net borrowers still have patchy access.
The concentration is highlighted through some data that the RBI statement provides. While deposit growth rates of public sector banks (PSBs) have remained at 24% for the fortnight of January 2, 2009 (exactly at levels of January 2008), those of private sector and foreign banks have more than halved from previous levels. This lends some credence to reports of a portion of deposits having migrated seeking safer havens of PSBs. At the same time, comparative deposit rates of public and private sector banks show that PSBs have actually paid higher deposit rates for short maturity funds (less than 3 months) than private sector banks and more or less comparable rates for funds with a tenor of six months upto a year.
Consequently, credit flows of PSBs have increased over the past one year from 20% yoy to 29%, while that of the private sector banks have fallen from 24% to 12%. Although there are other factors that will have influenced these trends, this illustrates the asymmetry in availability of funds that has built up over the past few months.
The second factor in increasing credit is a reduction in the risk spread above the cost of deposits that banks would build into their lending rates. The corporate outlook remains weak and unstable. Preliminary results of the October-December quarter of FY09 indicate that corporate performance has slowed quite sharply. Both operating and reported profits show a negative growth for a sample of companies whose results are currently available. Given the constraining effects on cash flows and associated risks of default, this is likely to have been one of the inputs into banks lending decisions.
There is moreover a fair degree of residual risk associated with the global economic environment, which has the potential to suddenly introduce volatility in the system, leaving banks facing a sudden increase in costs of funds. There is nothing in the global economic environment that will result in a revival of growth impulses, either through consumption or investment. In fact, deteriorating corporate performance might lead to another round of corrections in equities markets and subsequent turbulence in foreign capital flows.
There is also the issue that the banking channel by itself might not be adequate to intermediate the credit needs of borrowers, particularly corporate borrowers, in the near future. Nor might it be fair on banks to assume credit risks over and above prudent levels. Other credit channels, particularly bond markets, need to be boosted. This may, therefore, be the best time to implement proposals recommended by various committees.
There is yet another argument for fostering these channels. We still do not have adequate instrumentalities that facilitate the transmission channels for monetary policy signals. The development of a deep and liquid yield curve might actually have led to a faster translation of RBI’s signals into bond funds flows to corporates, which in turn provide credit quality signals for banks. This is grist to the mill for substantial future work.
—The author is vice-president, business and economic research, Axis Bank. These are his personal views