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S. D. Naik

In a sober mid-term review of the Credit Policy, aimed at keeping the economy on even keel, Dr Y. V. Reddy has looked beyond interest rate cuts and focussed on qualitative issues aimed at toning up the working of the banks and improving credit delivery, particularly to the neglected agriculture and small-scale industry sectors, says S. D. Naik.

THE most notable feature of the new RBI Governor, Dr Y. V. Reddy's maiden Monetary and Credit Policy Review is that the Bank Rate and the CRR were left unchanged. He did not succumb to the hype and intense pressure from banking and industry circles to further slash the rates even while promising to continue with the soft interest rate bias, and with good reason.

While the pursuit of soft interest rate structure over the past five years has no doubt been desirable, any further cut at this stage could have been counterproductive. In the April policy this year, the RBI had slashed the Bank Rate by 0.25 basis points to 6 per cent, taking it to a 32-year low.

The consequent steep decline in the deposit rates over the past five years has worsened the plight of savers, particularly the pensioners heavily dependent on interest income.

Along with the Bank Rate, the cash reserve ratio (CRR) was also gradually reduced from 11 per cent in August 1998 to 4.5 per cent in June 2003, thus releasing a huge amount of liquidity in the system. Thanks to the surfeit of liquidity, there is already a continuing downward pressure on interest rates.

For instance, the average call money rate moved down from 5.86 per cent in March 2003 to 4.64 per cent by October 2003. The 91-day and 364-day treasury bill yields declined from 5.89 per cent each to 4.94 and 4.72 per cent, respectively over the same period. Public sector banks cut their deposit rates from a 5.25-7 per cent range in March 2003 to 5-6 per cent by October 2003.

Against this backdrop, expectations regarding further rate cuts were clearly unrealistic and Dr Reddy has done well not to rock the boat at a time when the economy is poised for an upswing.

Based on the growth prospects across sectors of the economy, and assuming the continuing good performance of the industrial sector, the RBI has revised its estimate of GDP growth for this fiscal to 6.5-7 per cent, with an upward bias, compared to the earlier projection of 6 per cent. In fact, the economy may do even better as the Finance Ministry has termed the revised RBI forecast conservative.

Apart from the higher GDP growth forecast, the review of Credit Policy also refers to other positive developments, such as the surging foreign exchange reserves and the benign inflationary outlook. Foreign exchange reserves jumped by $17.2 billion to $92.6 billion between March 2003 and end October 2003. Export growth, which had slowed significantly in July and August, increased by a robust 16 per cent in September. With this, the export growth during the first half of the fiscal in dollar terms works out to 10 per cent in spite of the appreciating rupee.

Exports growth is expected to remain satisfactory during the second half of the year, thanks to the ongoing global recovery. More important, the US economy is showing a much faster than expected recovery and interest rates are showing signs of firming up.

Our import growth during April-September 2003 is also significantly higher, at 21.4 per cent, reflecting the pick-up in economic activity. This is also evident from the higher capital goods imports.

Hence, the Credit Policy statement says, the emphasis at this stage is on continuance of measures already taken with an accent on implementation, facilitating ease of transactions by the common person, further broadening of the consultative process and continued emphasis on institutional capacity to support growth consistent with stability in a medium-term perspective.

It is, therefore, proposed to consider strengthening of the credit delivery system to ensure that financing gaps do not seriously constrain the desired acceleration in growth.

The banking sector's apathy towards making available adequate credit to the productive sectors of the economy, particularly to priority sectors such as agriculture and small-scale industries, in spite of the surfeit of liquidity in the system, is well-known.

Even as the large unorganised sector in the economy is starved of institutional finance, public sector banks have been opting for the easier option of parking their surplus funds in government and other approved securities.

Scheduled commercial banks' investment in such securities, at Rs 87,754 crore this year (up to October 17), has been much higher than the Rs 72,110 crore, net of mergers, in the corresponding period last year. Commercial banks hold government and other approved securities much in excess of the prescribed statutory liquidity ratio (SLR).

The excess holding of SLR securities at Rs 2,53,474 crore, constitutes 16.6 per cent of net demand and time liabilities (NDTL) of banks. Thus, for the banking system as a whole, the effective SLR investment at 41.6 per cent of NDTL is far in excess of the statutory minimum requirement of 25 per cent. Apart from the subdued credit growth, the RBI is also concerned with the overall rigidity in the downward movement of lending rates as also the inadequacy in the quality of services to some sections, though deposit rates have fallen significantly over the past five years.

The RBI's policy stance, therefore, is directed at passing on the benefits of lower interest rates to all segments of customers, instead of only to large corporates and housing. Credit delivery to priority sectors such as agriculture and SSIs is sought to be improved with relaxation of security norms and other measures.The latest policy statement also reaffirms the need for banks to move towards a single prime lending rate (PLR) in consultation with the Indian Banks' Association (IBA) for better transparency and improving credit delivery to different sectors of the economy.

According to information supplied by the banks, the median lending rates on terms loans of public sector banks remained unchanged in the range of 11.5-14 per cent between March and June 2003 while the range of PLRs of these banks remained unchanged at 9-12.25 per cent.

Banks have been lending to large corporates and housing at sub PLR rates and to others, including priority sectors, at higher than the PLR.

The RBI Governor has also drawn attention to the continuing neglect of priority sectors. Over the past few years, commercial bank credit to agriculture and small-scale industries has continued to remain much below the targeted levels despite RBI guideline on this from time to time.

According to the Economic Survey 2002-03, advances to agricultural sector by public sector banks (PSBs) and private sector banks amounted to 15.8 per cent and 8.5 per cent of their respective net bank credit in 2001-02 against the prescribed target of 18 per cent.

Moreover, the distribution of credit to the sector remains highly uneven with banks targeting relatively risk-free irrigated areas and individuals with high net worth. Similarly, the share of small-scale industries in total bank credit of PSBs declined from 16.1 per cent at end March 1999 to 12 per cent at end March 2002. The reduction in the case of private sector banks over the same period was from a high of 18.8 per cent to 13.7 per cent.

In fact, in recent years priority sector lending has been reduced to some kind of a farce by including all sorts of loans in this category, including those to software and IT. In addition, banks have been allowed to make good the shortfalls in lending to agricultural sector by depositing the equivalent amounts with the Rural Infrastructure Development Fund (RIDF).

The defaulting banks have been merrily using RIDF to earn a good return instead of taking the trouble and possible risk of lending to farm sector. Now the RBI has taken some measures to discourage this practice and reduced interest rates payable to banks on such deposits by two percentage points across-the-board with effect from November 1, 2003.

As for lending to the SSI sector, the foreign banks were so far required to deposit an amount equivalent to the shortfall in their priority sector target with the Small Industries Bank of India (SIDBI) at an interest rate of 6.75 per cent.

In order to increase the flow of credit to SSIs and rationalise interest rates, it has now been decided to reduce interest rates on such deposits at the level of the Bank Rate (which is 6 per cent at present). Also, SIDBI has been asked to take appropriate steps to ensure that priority sector funds are utilised expeditiously and the benefits of reduction in interest rates are passed on to the borrowers.

Concerned over the continued neglect of priority sector lending, it has also been proposed to constitute an Advisory Committee on Flow of Credit to Agriculture and Related Activities and a Working Group on Flow of Credit to SSI Sector.

One wonders what purpose they will serve when a plethora of earlier committee reports both on agriculture and SSIs have been gathering dust.

The only positive measure in this respect is the permission now granted by RBI to further increase the loan limit without collateral to well-performing SSI units from Rs 15 lakh to Rs 25 lakh. Earlier, in April 2002, this limit was raised from Rs 5 lakh to Rs 15 lakh.

Micro-finance is another area that needs closer attention as it can serve as an effective instrument to alleviate widespread poverty, particularly in rural areas.

In recent years, micro-finance has helped the poorest people to improve their lot. However, the concept is yet to spread to such States as Bihar and Uttar Pradesh.

Interestingly, the majority of SHGs financed by banks have been set up by women who are not only saving for their families but are getting subtly empowered in the process. In these cases the leakages are virtually nil and the loan recovery rate is 98 per cent.

Against this background, the RBI wants to upscale the micro-finance schemes. On the basis of the recommendations of the four informal groups constituted earlier, the central bank now proposes to provide incentives to bank branches in financing self-help groups (SHGs), simplify procedures and provide flexibility to suit local conditions.

The RBI wants the approach to micro-financing to be absolutely hassle-free. It is also suggested that Nabard should reinforce its commitment to maintaining and enhancing the flow of micro finance.

It is evident from the foregoing that the thrust of the mid-term Credit Policy review is to look beyond the rate cuts and concentrate on addressing the various qualitative issues aimed at toning up the working of the banks and improving credit delivery.

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