Part II. Annual Statement on Developmental and Regulatory Policies for the Year 2005-06
I. Interest Rate Prescriptions
67. The deregulation of financial markets in the recent years has improved the competitive environment in the financial system and strengthened the transmission mechanism of monetary policy. Sequencing of interest rate deregulation has been an important component of the reform process which has imparted greater efficiency in resource allocation. The process has been gradual and predicated upon institution of prudential regulation of the banking system, market behaviour, financial opening and, above all, the underlying macroeconomic conditions. The interest rates have been largely deregulated except for (i) savings deposit accounts, (ii) non-resident Indian (NRI) deposits, (iii) small loans up to Rs.2 lakh and (iv) export credit.
68. The annual policy Statement of 2002 had weighed the option of deregulation of interest rate on savings accounts but the time was not considered opportune considering that bulk of such deposits are held by households in semi-urban and rural areas. It has, however, been argued that deregulation will facilitate better asset-liability management for banks and competitive pricing to benefit the holders of savings accounts. As regards NRI deposits, interest rate ceilings on FCNR(B) deposits are linked to LIBOR/ SWAP rates of corresponding foreign currencies, while NRE deposit rates are linked to US dollar LIBOR/SWAP rates. These stipulations have been put in place taking into account their implications for the banking system and the management of the capital account.
69. As regards lending rates, given the limited ability of small borrowers to manage interest rate risk and for ensuring availability of credit at reasonable rates, interest rate ceiling on small loans up to Rs. 2 lakh is linked to BPLR. The contrary view is that given the competitiveness in the credit market, high share of sub-BPLR lending and increasingly broad-based credit structure, availability of credit to all segments of the economy at a price consistent with their risk profiles becomes important. Further, it is argued that lending rate regulation has dampened larger flow of credit to small borrowers. In addition, the current regulation seems to have imparted an element of downward rigidity to BPLR. It may be noted that RRBs and co-operative banks are free to determine their lending rates and there are no restrictions on lending rates of micro-finance institutions (MFIs).
70. Interest rate regulation on export credit has been favoured for making available credit to exporters at internationally competitive rates. The annual policy Statement of April 2002 had indicated that "linking of domestic interest rates on export credit to PLR has become redundant in the present circumstances as effective interest rates on export credit in rupee terms is substantially lower than the PLR". The mid-term Review of October 2002 had mooted deregulation of interest rate on rupee export credit in phases to encourage greater competition in the interest of exports. One view is that in the light of competitive lending rates in the economy, it is important to ensure that regulated interest rates should not restrict credit flow to all segments of exporters with different risk profiles.
71. While there is merit in moving forward to impart greater competitiveness and depth to the activities of the financial system by further deregulating interest rates in some segments which have hitherto remained regulated for various reasons found relevant at different stages, it is proposed to continue with status quo as various issues pertaining to above regulations on interest rates are being debated.
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