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Bank Rate Bottom

Can the RBI’s bank rate go any lower than the present 6.5 per cent? The scenario.

Dipping times

Corporate India wailed for it. Corporate India got it. In fact, ever since Bimal Jalan took over the reigns of the Reserve Bank of India (RBI), back in 1997, he has worked assiduously (some say single-mindedly) towards a soft interest rate regime in India.

Today, no Indian corporate can complain that a high cost of capital prevents it from turning globally competitive. The RBI’s bank rate, which serves as the benchmark for interest rates in India, is down to 6.5 per cent -- even three years ago it was 11 to 12 per cent -- and the cash reserve ratio (CRR) is down to 5.5 per cent.

That’s monetary stimulus at its best. But the Indian economy shows only half-hearted signs of rousing itself out of its prolonged slump. Should the RBI loosen monetary policy further by effecting another interest rate cut?

No. That seems to be the view of monetary policy-watchers, not to mention the view of the chief policymaker himself, Jalan. “I cannot say about October, but we are not contemplating a rate cut now,” the RBI Governor is reported to have said when asked whether the central bank was planning a cut before its mid-term review of monetary policy in October.

So, there you have it. No interest rate change, but with a ‘cut’ bias -- a clear signal that the soft-rate regime is here to stay.

Indian economists have echoed their approval. A cut at this juncture will not boost economic output, they say. The reasoning: banks are flush with funds, but investments are going slow for reasons other than cost of funds. Aggregate demand remains stagnant, dozens of industries are wracked by overcapacity, and fresh projects remain too scarce to absorb the loans that banks are ready to extend. In other words, India is experiencing what economists call a ‘liquidity overhang’.

In any case, interest rates cannot keep going lower and lower. The danger? The economy could slip into a ‘liquidity trap’ a la Japan, where interest rates went so low that nobody wanted to part with money, regardless of the official rates. Of course, Japan also underwent deflation (a condition that makes a liquidity trap hard to avoid).

Inflation in India has been positive but subdued, making a low interest regime possible in the first place. Interest rates, remember, are linked less with current inflation than with inflationary expectations. And on this count, experts say that the past few years’ trend could abruptly change later this year or early next year (on account of an oil price driven spiral, perhaps). Uncertainty prevails. This is another reason that the Bank Rate seems to be at its lower limit.

Then, there’s the poor beseiged banking sector to think about. India’s NPA problem isn’t something to whistle one’s way through, and spreads are already under severe pressure. The lower interest regime has made it difficult for banks to charge a risk premium on loans that are less than fully safe. Currently, banks’ prime lending rate (PLR), the rate at which they lend to top-notch clients, is in the 11-12 per cent range. Some loans are being made even below this rate. Any more cheap lending, without a full-throttle economic recovery on the horizon, could endanger the Indian banking system.

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