In view of
the paramount need to support industrial recovery, the Monetary
and Credit Policy Statement in April had stated that "the
current stance of monetary policy will continue to be in the
direction of facilitating adequate availability of liquidity along
with stable medium and long-term interest rates, with policy
preference for softening to the extent circumstances permit."
This stance of monetary policy was already reflected in the
measures announced by the Reserve Bank on March 1,1999, when the
repo rate was reduced by 2 percentage points and the Bank Rate and
the Cash Reserve Ratio were reduced by 1 percentage point and 0.50
percentage point, respectively. The Cash Reserve Ratio was further
reduced by 0.50 percentage point in April 1999. Following the
RBI's measures, banks and financial institutions also announced
their decisions to lower prime lending rates.
In line with
the above stance, during the first half of the current financial
year, the Reserve Bank has been closely monitoring the overall
liquidity conditions in the market as well as the behaviour of
interest rates. So far as liquidity conditions are concerned, by
and large, they have remained generally easy owing inter alia, to
growth in bank deposits and the cuts in Cash Reserve Ratio
announced in March and April 1999. Non-food bank credit has also
recorded an increase during this period by Rs.14,802 crore in
contrast with an increase of Rs.8,181 crore during the first half
of 1998-99. The increase in investments by banks in commercial
paper, bonds/shares/ debentures of PSUs and private corporate
sector during this period, however, showed an increase of about
Rs.6,314 crore during April-September 1999 against Rs.9,359 crore
in the corresponding period of 1998-99.
There has
been a reduction in yields and interest rates on Government
securities and Certificates of Deposit in the first half of the
current year. So far as the Government securities are concerned,
the yields have fallen by 46 basis points for 10-year paper in
October 1999 compared with the yields in March 1999. The discount
rates on Certificates of Deposit have declined from 10.00 per cent
to 8.50 per cent for three months maturity and from 12.50 per cent
to 11.00 per cent for one year maturity, between April and early
September, 1999. There was also a decline in prime lending rates
of public sector banks from the range of 12.75 - 14.50 per cent at
the end of February 1999 to 12.00 - 13.50 per cent in October
1999.
While
liquidity conditions have generally been easy, overnight call
money rates have tended to be firm during the first half of the
year compared with the position in the corresponding period of
last year. The fortnightly average rates were in the region of 7.7
to 9.9 per cent for the most part as compared with 6.1 to 9.8 per
cent last year. Part of the reason for this may be attributed to
the pick-up in demand for credit and greater opportunities for
investments in medium and long-term paper. (In the first fortnight
of October 1999, however, call money rates, shot up to a high of
20.0 per cent for a few days mainly because of miscalculation of
CRR requirements by some banks and low level of lending by major
lenders in the call market.)
The hardening
of short-term interest rates was also reflected in an increase in
the cut-off yields on Treasury Bills. The yields on 91-day and
364-day Treasury Bills showed an increase during the first half of
the current financial year of about 46 basis points and 75 basis
points respectively, over the corresponding period of last year.
On the whole, while liquidity conditions have been comfortable and
medium and long-term rates have tended to soften, there has been
some pressure at the shorter end of the yield curve.
In order to
cool down the pressures on call money market during the first half
of October, the Reserve Bank opened a purchase window for Treasury
bills as part of its open market operations. It is the intention
of RBI to continue with this practice as and when considered
necessary and, over time, to develop a two-way market operations
in Treasury bills. In due course, with further development of
Treasury bills market, such action should enable RBI to confine
its activities to secondary market operations in Treasury bills,
obviating the need for any devolvement in primary auctions.
In view of
the decline in inflation rates in the past few months, and a
relatively favourable outlook for the year as a whole, there is a
case for a further downward movement in the structure of interest
rates. The Reserve Bank has already indicated its policy
preference for softening of interest rates to the extent
circumstances permit. It, however, needs to be stressed once again
that prime lending rates of banks for commercial credit are
entirely within the purview of the banks and are no longer set by
the Reserve Bank. The interest rates which are subject to
regulation are only the rate of interest on savings accounts
(which is 4.5 per cent), and rates of interest on export credit
and credit for small and tiny sectors, including DRI schemes, up
to an amount of Rs. 2 lakh. Decisions in regard to interest rates,
therefore, have to be taken by banks themselves in the light of
various factors, including their own cost of funds, their
transaction costs, and interest rates ruling in the non-banking
sector, etc.
While greater
flexibility in interest rates is a most desirable objective, it
has to be recognised that banks face several structural and other
constraints. Among these are:
- For the public sector
banks, the average cost of funds is in the region of 8 per
cent. The non-interest operating expenses work out to 2.5 to
3.0 per cent of total assets, putting pressure on the required
spread over cost of funds leading to high lending rates.
Relatively high overhang of NPAs together with interest tax
pushes further the lending rates.
- Banks do have the freedom
to offer variable interest rates on longer term deposits.
However, the preference of depositors for as well as the
traditional practice with banks is to offer fixed interest
rates on term deposits. The effect of this practice is to
reduce the flexibility that banks have in lowering their
lending rates since the rates on the existing stock of
deposits cannot be lowered.
- There is persistent and
large volume of market borrowing requirements by the
Government giving an upward bias to the entire interest rate
structure.
- Interest rates on
contractual savings like Provident Fund, National Savings
Scheme are substantially higher than long-term deposit rates
of banks. Provident Fund rates are generally in the region of
12 per cent and National Savings Scheme rate on 4-year
deposits is 11 per cent as compared with the bank deposit rate
of 10-12 per cent for similar maturity. Similarly, private
sector mutual funds offer a much higher rate of interest than
those offered by banks on their term deposits. Compared to
bank deposits, many of the other saving schemes and mutual
funds carry larger tax benefits.
- The level of CRR continues
to be high in view of the need to control the overall
expansion of liquidity in the system. A high level of CRR also
raises the average cost of funds for banks.
From the
short-term and long-term points of view, in the context of
financial sector deregulation and industrial liberalisation,
priority needs to be given to removing some of the above
constraints so that the interest rate structure can be made more
flexible during different phases of the business cycle. An
important policy priority of the Reserve Bank, Government as well
as banks must be to undertake concrete steps in this direction as
early as possible.
As mentioned
in the April Statement, the Bank Rate and short-term repo rate
have been increasingly perceived by the markets as signals for
movements in market rates of interest, particularly call money
rates. The changes in CRR have served as one of the important
instruments for regulating liquidity, and have been effective in
meeting the short-term challenges in domestic money and forex
markets. The Interim Liquidity Adjustment Facility has also helped
in keeping the money market rates range bound. The
medium/long-term objective of monetary policy will continue to be
in reducing the average level of CRR, while in the short-term it
could be varied in both directions depending on the behaviour of
monetary indicators.
With the use
of multiple indicator approach, the position in the financial
markets will continue to be assessed by movements in money market
interest rates, exchange rate, foreign exchange reserves, credit
to Government and commercial sector and fiscal position of the
Government besides real sector developments. Constant efforts are
being made to explore the relationships among different sectors of
the economy through a short-term operational model which will also
be useful in understanding the transmission mechanism of monetary
policy. In this respect, the estimates of the new monetary
aggregates (based on the recommendations of the Working Group on
`Money Supply: Analytics and Methodology of Compilation'), both
from the component and sources side, compiled and released in the
October issue of RBI Bulletin are likely to be helpful.
Apart from
price stability, central banks all over the world also accord
importance to financial stability as a policy objective. RBI has
been making continuous efforts towards strengthening financial
soundness by prescribing capital adequacy norms of banks and
financial institutions, advising improvements in asset
classification and accounting systems and establishing best
practice norms for income recognition and provisioning against
exposures faced by them. Following the recommendations of the
Narasimham Committee II, the RBI had, in October 1998, announced ,
inter alia, a range of specific prudential norms for banks which
have since been progressively implemented. The thrust in this
direction was carried forward in the April 1999 Statement enabling
banks not only to adopt prudent accounting standards but also to
allow some measure of freedom in managing loan accounts, and
operation of ALM guidelines for financial institutions. Moving
further from the gains of ALM system, banks are encouraged to put
in place comprehensive risk management systems to take care of
credit risk, market risk and operational risk. After holding
consultations with banks, RBI has recently provided detailed
guidelines in this regard. RBI also places utmost importance on
the quality and standards of supervision which have been
progressively refined under the dispensation of the Board for
Financial Supervision (BFS) ever since its establishment.
Sustained reforms in this area during the last few years have
significantly improved the outlook with respect to overall
financial sector stability in India. RBI would continue to review
the position with regard to the issues integral to the maintenance
of financial stability in the future.
The Bank's
overall stance of policy for 1999-2000 would continue to be :
provision of reasonable liquidity; stable interest rates with
preference for softening to the extent possible within the
existing operational and structural constraints; orderly
development of financial markets and ensuring financial stability.
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