Banks under pressure to cut lending rates

Published October 5, 2015
RBI governor Raghuram Rajan says India’s recovery is far from robust.—AFP
RBI governor Raghuram Rajan says India’s recovery is far from robust.—AFP

FOR someone who was considered an outsider, Raghuram Rajan was expected to chart an independent course of action as governor of the Reserve Bank of India.

The ex-professor of finance at the University of Chicago and the former chief economist of the International Monetary Fund, had in 2005 warned of the possibility of a global economic crisis.

But many dismissed his fears until the 2008 crisis surfaced. Later that year, former Prime Minister Manmohan Singh brought him to India and made him his economic adviser; four years later he was promoted as the chief economic adviser to the government, and a year later as the governor of the RBI.

Ever since his elevation as the head of the Indian central bank, Rajan has had an uneasy equation with the government over his tight monetary policy. In fact, just last week maverick BJP supporter and former union minister Subramanian Swamy demanded Rajan be sacked if he did not cut interest rates. “PM must make clear to RBI Governor: Rate cut now or Rajan cut right away,” tweeted Swamy.

Of course, it’s not so easy to sack a Reserve Bank governor. Just two RBI chiefs were replaced in the past when there was a change in regime in Delhi — once in 1977 and the second time in 1990.

In fact, when the BJP won the general elections last year, there was speculation that the party might replace him, as many leading lights had been critical of his move over the previous year to raise interest rates to battle inflation.

But saner counsel prevailed and the new government did not ease him out. However, senior ministers and politicians, besides business lobbies and industrialists have been unhappy with Rajan over the past 18 months for stubbornly refusing to slash interest rates.

The governor cut interest rates by 0.25pc on three occasions this year, but the moves did not satisfy the government or the business lobbies. Last week, however, Rajan did opt for a massive 0.5pc slash in the repo, the key interest rate, in his bi-monthly monetary policy. Of course, no one believes he did it under pressure from politicians such as Swamy or from ministers in the Narendra Modi cabinet.

Ever since he took over as the governor of RBI, Rajan has mastered the art of taking markets and analysts by surprise. Indeed, no one expected the 50 basis points cut in interest rates last week, and most analysts and experts were expecting yet another 25 basis points reduction in rates.

The repo rate now stands at 6.75pc, the lowest in nearly five years. Industry bodies and business executives welcomed the decision and felt it would help in accelerating economic growth. “We have been strongly advocating the need for deeper rate cut and are highly encouraged by the accommodative policy stance taken by the RBI,” said Dr Jyotsna Suri, president, Federation of Indian Chambers of Commerce and Industry. “We are equally enthused by the commitment shown by the government to facilitate the transmission by reviewing the framework of small savings.”


RAJAN has often complained that despite the RBI slashing rates over the past few months, banks have not been transmitting the reduced rates to borrowers. Earlier this year, after a 0.25pc rate cut, Rajan slammed banks for continuing to blame the central bank for high interest rates.

“When banks have to raise rates, they quote higher policy rates,” he had said. “Why don’t they cut rates when policy rates go down?” He had also dismissed “the notion that rates haven’t fallen as nonsense.” Banks were sitting on money, but were reluctant to lower rates, the governor had said.

Though the RBI had reduced the repo rate from a high of 8pc, banks continued to charge double-digit interest from borrowers, both industrial and ordinary retail consumers. Banks though resisted reducing interest rates because of the high interest rates that small saving institutions of the government paid to the general public.

Small savings institutions including the post office and the employee’s provident fund organisation pay interest rates as high as 8.7-8.8pc. If banks were to reduce their rates, they would not be able to attract substantial deposits. Banks currently offer less than 8pc interest on long-term fixed deposits, whereas a three-year term deposit in the post office fetches an interest of 8.4pc.

The public provident fund scheme gets a saver 8.7pc, whereas investments in National Savings Certificates get a return of 8.8pc cent. Of course, small savings add up to a fraction of the total bank deposits, but there are nearly 300 million Indians who have invested in small savings schemes.

Trade unions are also vocal and have opposed any cuts in interest rates of provident fund schemes. Successive governments have over the years been in a dilemma while deciding interest rates, especially for the provident fund scheme.

After slashing the repo rate, Rajan hinted that it was now for the government to take action to ensure that banks also reduced rates. “While the Reserve Bank’s stance will continue to be accommodative, the focus of monetary action for the near term will shift to working with the government to ensure that impediments to banks passing on the bulk of the cumulative 125 basis points cut in the policy rate are removed,” he said.

Jaitley responded quickly and said the government planned to initiate action to help the economy realise its medium-term potential growth rate. And a senior government officer disclosed that interest rates on small savings schemes would be reviewed, though the interest of small savers would be kept in mind.

Banks, however, were quick off the mark and most of the major lenders reduced their rates. State Bank of India, the country’s largest commercial bank, cut rates by 40 basis points. Others including Andhra Bank, Bank of India, Punjab National Bank, IDBI Bank and Axis Bank also announced a reduction in interest rates.

Published in Dawn, Business & Finance weekly, October 5th , 2015

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