Nudge and cut?

RBI pushes banks to cut rates. The entire gamut of interest rates needs to be brought down

RBI Governor D. Subbarao gave another signal to banks to cut interest rates. Though the repo and reverse repo rates were cut by merely 25 basis points,it was significant in that it was another nudge to banks to reduce rates. In recent months even though the RBI has cut rates sharply,lending rates of banks have not come down. The RBIs approach has been to watch and wait and nudge banks towards reducing their rates rather than aggressively cutting rates. If in response to this policy move,banks do move and cut rates,the RBI should cut rates further in the coming weeks. It should also cut the Cash Reserve Ratio,which is a tax on the banking system and needs to be removed,especially at a time when bank balance sheets are going to be under stress. If the credit policy announcement is not followed up by additional steps that push the policy in the direction which it is suggesting,it is going to have very little

impact. A 25 basis point cut on its own would be too small to matter.

In the light of lower growth forecasts for 2009-10,it is necessary to bring down the entire gamut of interest rates. The new government will have to address the question of small savings rates. As long as small savings rates are fixed at 8 per cent or above,banks will argue that it will be difficult to bring down deposit and hence lending rates significantly. While to some extent the RBI has succeeded in both deposit and lending rates being lowered,it will be hard for this process to continue if there remain rigidities in the system. They should be linked to rates such as the 91-day bill rate. There is no argument for the RBI to administer the savings deposit rate,which is currently fixed at 3.5 per cent. To push rates lower,these rigidities should be removed.

Lowering rates will,however,face a problem because of the governments large borrowing programme. This problem could easily persist for the next few years as a result of the rise in debt and the fiscal stimulus in the current slowdown. To solve this issue the government needs to reduce intermediation costs and expand the size of the bond market. It should set up the Debt Management Office,allow foreign investors to purchase government bonds,create a government bond market in which retail investors as well as agents other than banks and big financial firms can easily participate.

Former Punjab DGP and retired IPS officer Mohammad Mustafa

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Former DGP Mohd Mustafa and his wife, former minister Razia Sultana, are facing an FIR for the death of their son, who had accused them of harassment and conspiracy. Mustafa, a decorated officer who joined the Congress after retiring, actively campaigned for his wife in the 2022 Assembly elections, but was also booked for making communal remarks during the campaign.

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