The reason why interest rates have not fallen as steeply as they should have is that the signal from the bond markets has been to the contrary, says industry body CII.
''The Government and RBI should find a way to manage the government borrowing programme so that bond yields do not remain out of line with the fundamentals of the economy," said Venu Srinivasan, President, CII.. "Lending rates should have fallen much faster, given the current weakness in real economic data and the decline in inflation.''
According to CII, if the yields on government securities remain high, banks will not be able to reduce their lending rates and Indian companies and consumers will continue to face one of the highest interest rates in the world. Further, this will encourage banks to park their funds in government bonds and the liquidity created by the RBI's actions will not flow to the real economy.
In its meeting with the banks and economic secretaries, chaired by the cabinet secretary to discuss the flow of credit from banks to industry, CII has made the following recommendations for dealing with the current economic slowdown:
- 50 basis point reduction in repo and reverse repo rates to 4.5 and 3.0 per cent respectively;
- 50 basis point reduction in the Savings Bank rate
- Targets to be set by the RBI for monetisation of the deficit together with a relaxation of the FRBM Act.
CII says the second issue is that banks have become risk averse since the onset of the financial crisis and have slowed their lending fearing an increase in default rates.
With bank credit growing at around 18 per cent currently, it is unlikely that the RBI's target of 24 per cent for FY2009 will be met. Credit to MSMEs has been particularly weak, inhibiting their ability to deal with such issues as elongated payment cycles.
It said the RBI needs to take additional measures to step up bank credit, especially since other sources of funding such as equity issues have completely dried up. For MSMEs, the RBI could consider setting a sub-target under priority sector lending. The RBI may also consider pushing back the adoption of Basel II norms for a year in order to ease pressure on banks' capital ratios.
Third, the government and RBI need to take some steps to attract more foreign savings using the NRI deposit route. For this, it called for a deregulation of interest rate on FCNR / NRE deposits. The RBI had started linking the FCNR / NRE rates to Libor in 2004 in order to reduce NRI flows, once the rupee began appreciating. Now that the currency is facing depreciationary pressures this ceiling on interest rates is now proving an impediment to.
CII had earlie suggested the formation of an informal group comprising banks, government, RBI and industry to deal with sectoral issues and said it welcomed the approval of the cabinet secretary for forming such a group.
The industry body also recommended some changes in the steps taken by the RBI. For example, NBFCs should have direct access to the RBI for the refinancing that is currently available to them via commercial banks. This would lower the interest rate at which NBFCs can access funds. Similarly, the commercial vehicle sector should have a direct refinance window from the RBI, given its eligibility for priority sector funding.
IOt also wants an improved flow of funds to specific sectors, including infrastructure, NBFCs, automobiles and auto components, housing, SMEs, textiles, gems and jewellery and exports. To take an example, CII recommended that the exposure limits of banks have to be relaxed to satisfy the requirements of the infrastructure sector. The cost of funds also needs to come down to make projects in the infrastructure sector viable. This can be done by providing a refinance window to banks against lending to the core sector.
The global financial crisis has severely impacted India's exports, which are dominated by small and medium scale enterprises in labour-intensive sectors such as textiles, leather, gems and jewellery, plastics and farm products. The global crisis has increased the difficulty for Indian exporters to raise funds, especially in foreign currency. CII suggested that long-term loans on concessional terms be provided to qualified Indian exporters with good track record in past three years. These loans would help in providing marketing assistance to exporters, especially from small and medium sized enterprises.