Business Today Net Special

The Gugv's Remedy

For banks, the 2-percentage point cut in cash reserve ration (CRR) is a windfall. And the half a per cent in bank rate will encourage borrowing. But will the RBI governor's move help revive the economy?

By Ashish Gupta

It was the best possible prescription under the present circumstances. The Central Bank's decision to cut cash reserve ratio (CRR) and the bank rate by 200 and 50 basis points per cent respectively--in its recent mid-term Monetary & Credit Policy--was not only a clear signal to move to a soft interest rate regime but also a wake-up call for the government and Corporate India. To take some urgent steps to break out of the near recessionary conditions that has been afflicted the Indian economy for the last one- and -a -half years, though some believe it is much longer.

After all, a two per cent CRR cut, would in regular times, have meant an additional inflow of Rs 20,000 crore into the system. But with the RBI doing away with the whole system of concessional CRR for certain term deposits like non-resident Indian accounts--FCNR (B) accounts, Indian Millennium Deposits (IMD) accounts, only Rs 8,000 crore would now be injected into the system. And a cut in bank rate by 50 basis points will also translate into lower interest rates on savings and time deposits.

But will such a move help revive the Indian economy? There seems to be no near unanimity on such a crucial question. Argues Saumitra Chaudhury, economic adviser, credit rating agency, ICRA: "The apparent moolah from the massive CRR cut is something of an optical illusion.'' The money, according to him will reimburse the banks for the reduction that they will have to make in their prime lending rates (PLR) eventually because of the recently announced cut in the bank rate.

The banks, after all, are facing a major asset-liability mismatch in the event of any cut in interest rates. While the interest paid by individuals and corporates on loans are paid at the current interest rates, banks have to shell out much higher interest rates on fixed deposits made during higher interest rate regime. "The new interest rate only becomes applicable once the fixed deposits come up for renewal, '' adds a banker.

Then there are other constraints too. Banks are already overflowing with funds in the absence of viable, new projects. After all, in times of economic downturn good-quality borrowers are loath to increase their financial risk by increasing their borrowings. And with the RBI coming out with stringent prudential norms, bankers too will be wary of lending to risky borrowers who may default in the long run and hence increase their NPA level.

As on October 5, 2001 total deposits with commercial banks were to the tune of Rs 10 lakh crore and any reduction in CRR would only add to the liquidity of the banks. So what will the banks do with the additional funds?

The only way out for the banks in such times is to invest in government securities (G Secs) and hence fund the government's fiscal deficit, which is almost certain to be much larger than that indicated in this year's Budget document. For instance, commercial banks increased their lending to the government by Rs 47, 951 crore as compared to Rs 29,380 crore last year. So what it means is that the government will have much more money to borrow.

However, Ravi Trivedy, Executive Director, PriceWaterhouse Coopers, believes that in case some of the government's infrastructure projects take off, this source of cheap fund will help a number of sectors like cement and steel expand their existing business or launch new projects to take care of the increasing demand.

But one thing is sure. The governor has shown the way. It is now up to the North Block to take heed and act.

Issue Contents Write to us Subscription Syndication