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No trickledown yet of falling rates

P. Devarajan

THERE is some talk on the merits of the central bank switching to a floating or daily repo rate as the extant 4.5 fixed repo rate is providing some players with assured returns.

Some bankers think that the Reserve Bank of India (RBI) could announce every morning the day's repo rate based on its market perception and force players with excess liquidity to take risks.

It may or may not work but a daily repo could provide a peep into RBI's mind on future interest rates and seemingly the issue has been discussed by the players with the central bank.

Surplus rupee funds seem to be mocking various theories held on the shape of the yield curve. Today, the repo rate is 4.5 per cent, call is between 4-4.5 per cent while the 10-year bond offers an yield of about five per cent having dipped to 4.99 per cent.

These numbers may at best offer a zig-zag scribble than a curve.

An important objective behind setting up the Liquidity Adjustment Facility (LAF) "is the maintenance of orderly conditions in the overnight market by providing an informal corridor of the repo and reverse repo rates," says the RBI's Annual Report 2002-03.

An analysis of daily data indicates that the number of days on which the call money exceeded the upper corridor declined from 27 in 2000-01 to 16 in 2002-03.

The call rate fell below the corridor on 91 days during 2002-03, up from 32 in 2000-01.

"Importantly, the differential between the two rates declined sharply from 43 basis points to only five basis points over the same period," says the report.

In it, the RBI admits: "The conduct of monetary policy is faced with the dilemma of surplus liquidity in financial markets together with inadequate credit demand in the context of financing sustained growth in the real sector."

As a way out, the suggestion has again surfaced of infrastructure lending being termed as priority lending. Now the priority norm is 40 per cent with a sub cap of 18 per cent for agriculture and most banks have fallen short of the target.

Including infrastructure could lend a sense of urgency and probably get banks to be more active.

Currently, an infrastructure loan is priced at 10-13 per cent when there could be takers for infrastructure loans at nine per cent.

Could the RBI think of classifying infrastructure as priority sector lending provided banks give an undertaking that they will not charge beyond nine per cent?

It makes no sense if the excess liquidity does not work down to a cut in bank lending rates and help the real economy. Low market rates have brought in huge profits to banks, which, in turn, have not been shared.

"Banks have improved their profitability by passively investing largely in Government securities, reaping trading gains with the declining yields and rising prices. In this context, the improvement in banks' post-tax profits, while welcome, does not provide much room for comfort in the medium term," concedes the report.

All the financial market reforms have not helped private and public investors get cheap bank funds in line with market rates.

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