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WORRIED LOT RBI Governor D. Subbarao (centre) and Deputy Governors K. C. Chakrabarty (left) and Subir Gokarn arrive for a meeting to announce the half- yearly review of RBI’s monetary policy in Mumbai last week |
Deregulation of savings bank interest rate is an important step
Although it was most keenly anticipated, the 25-basis point hike in the repo rate to 8.50 per cent has been less of a surprise than two other announcements. The Reserve Bank of India's statement, as part of its forward looking guidance, that “notwithstanding current levels of inflation persisting till December, the likelihood of a rate action in mid-December review is relatively low'' is the clearest indication that monetary tightening that began in February, 2010, is coming to an end. The second significant announcement is the one relating to deregulation of savings bank deposit rate. As always, inflation has been the dominant concern of policymakers. The apex bank's indication of a ‘pause' in the interest rate action has been welcomed by industry and banks. Of course, there are caveats to this long-awaited policy statement. The central bank expects the inflation rate to start declining from December “and then continue down a steady path to 7 per cent by March, 2012.” (The RBI has retained its inflation projection for March 31, 2012, at 7 per cent). It is expected to moderate further in the first half of 2012-13. The projected decline in inflation is partly attributed to the fall in commodity prices and partly due to the cumulative impact of monetary tightening. Further, moderating inflation rates will in turn impact favourably on commodity prices. These expected outcomes will give room for monetary policy to address growth concerns in the short-run. However, monetary policy's traditional trade-off between supporting growth and curtailing inflation — till now heavily tilted towards the latter — has only slightly become more evenhanded. As always, monetary policy actions will have to respond to changing macroeconomic conditions. Inflation risks continue to remain high over the medium-term. Several factors are responsible for this — structural imbalances in agriculture, infrastructure capacity bottlenecks, distorted administered prices of several key commodities and the tardy pace of fiscal consolidation. These risks can only be mitigated by concerted policy actions on several fronts. The slow progress in some of these has been causing concern. For instance, on the crucial area of fiscal consolidation, the Finance Minister has said that it may not be possible to rein in the fiscal deficit to within 4.6 per cent of the GDP as projected in the Union budget. The RBI has categorically stated that in the absence of progress on some of these key issues over the medium-term, the monetary policy stance will have to take into account the risk of inflation surging in response to even a modest growth recovery.
Freeing SB deposit rates
Three favourable outcomes are expected from the policy action and guidance — on the basis of a credible commitment to low and stable inflation, medium-term inflation expectations will remain anchored; the emerging trajectory of inflation, which is expected to begin to decline in December, 2011, will be reinforced; and these two in turn will stimulate investment activity. Announced as part of the review covering developmental and regulatory policies, deregulation of savings bank interest rate is an important step, having deep implications for banks as well as their customers. For nearly eight years until May this year, the savings bank deposit rate remained at 3.5 per cent after which it was raised to 4 per cent. In another move that had benefited the customers, the RBI asked banks to calculate interest on the daily balances in their accounts. Until then banks were calculating interest on the minimum balance in the customer's account between the tenth and last date of the month. It is not clear whether, after deregulation, banks will continue to pay interest on the daily balances or switch to some other mode such as monthly or quarterly basis. Deregulation of savings bank deposit rates has taken place long after all other deposit rates and most rates on advances were freed. Experience so far with deregulation has been satisfactory. It has spurred competition in the financial sector, imparted greater efficiency in resources allocation and strengthened the transmission mechanism of monetary policy. However, even with all the perceived benefits from the earlier deregulation, freeing savings bank interest rates was by no means a given. An RBI discussion paper, circulated six months ago, was tilted towards deregulation, even while listing the pros and cons of such a move.
Opposition to the move has specifically centred on the following:
Savings bank accounts are predominantly used by the not so well-off and those in rural areas. The regulator and not individual banks is better equipped to take care of these account holders. However, the argument has lost much of its weight in a scenario where the opening of the financial sector so far has passed on the benefits all round. It is not inconceivable that even the vulnerable sections will benefit from the freeing of saving bank interest rates. Innovation will get a boost as banks engage each other in a combination of price and non-price competition. Most public sector banks and even some leading private banks such as ICICI Bank and HDFC Bank have a high proportion of savings bank deposits. Over time, these banks have come to depend on these low cost deposits for bridging their asset-liability mismatches. While technology application and innovation will enable some of these banks to retain their edge, the fear is that decontrol will lead to some reckless bidding by a few banks. That would be injurious not only to them but the entire financial sector. However, it has been pointed out that term deposit interest rates have been freed for quite a while and barring isolated instances have tended to converge within a narrow range. For the common man, the savings bank account is the first and often the only point of contact with the banking system. It is about time that a major disincentive in the form of low, administered deposit rate is removed.
HBL
