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Nothing much can happen….
The second bi-monthly monetary policy statement: 2015-16 of the Reserve Bank of India (RBI) announced: “it has been decided to reduce the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 7.5 per cent to 7.25 per cent with immediate effect and to keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4 percent.”

While the corporate sector was expecting a larger reduction in the repo rate, the regulator has very cautiously reduced it by only 25 basis points. As the speculation about the rate reduction was so high, there was carnage in the stock market. And the downtrend has continued for a few days.

 

Limitation of monetary policy…

This is the third time the repo rate has been reduced during the year. There is hardly any evidence to indicate that the transmission of the earlier rate cuts by 50 basis points have resulted in commensurate decline in the average lending rate of the banking sector. Nor is there any record of substantial increase in credit intake by the corporate sector, induced by the rate reduction. This is partly because of the implicit reluctance of the banks to increase their credit outlay because of the bulging volume of gross non-performing assets.  According to a forecast about the growth of non-performing assets, the banks are likely to be saddled with a gross NPA ratio of 4.5 per cent by the end of next fiscal.

It must be accepted that changes in monetary policy alone cannot bring about the desired changes in the total economic situation. The monetary policy statement has rightly emphasised this aspect, stating: “monetary easing can only create the enabling conditions for a fuller

government policy thrust that hinges around a step up in public investment in several areas that can also crowd in private investment. This will be important to relieve supply constraints and aid dis-inflation over the medium term.”


Food inflation is a major hold back…

Food inflation is one of the major issues that create hurdles in the management of monetary situation. The vulnerability of Indian economy caused by the truant monsoon continues to be an inescapable feature, beyond the control of any well-conceived planning process. The Metrological Department has predicted that monsoon would be below normal this year. The untimely rain has already created havoc in the farming sector in many states. The central bank or the banking sector itself can play only a limited role under such circumstances.

“Strong food policy and management will be important to help keep inflation and inflationary expectations contained over the near term,” the Monetary Policy Statement has categorically stated.

Cash Reserve Ratio has not been reduced for a valid reason. A reduction in it no doubt increases the banks’ lendable resources.  But it does not enable them to expand their lending remuneratively, since their cost of funds is higher than the current repo rate.

 

Strain on banks’ bottom lines

The reluctance of banks to pass on the benefit of a reduction in the lending rate as expected by the regulator, arises out of the growing strains on their bottom lines at present. The unprecedented increase in the contaminated assets has made an inroad into the net profits on many of them, including the bigger and stronger banks in the public sector.  Majority of the public sector banks have witnessed an increase in their net NPA ratios during FY 2015. The provision coverage ratio also has come down in the case of a few of them.  The wage revision announced recently is going to make a dent on the net profit of many of the banks. Provision for this has already been made in the published balance sheet.

Despite the, declining net interest margin, some banks have dutifully passed on the benefit of reduced rate of interest to their borrowers. In their ‘magnanimity,’ they should not hurt the depositors by reducing the deposit rates, which some of them have already done selectively.

 

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