Monday, July 5, 2010

News 4th July

Repo rates Up, BPLR system shifted to base rates

Inflation on its rise with WPI rise of 10.16% in May and the soaring prices of non-food manufactured products like metals, textiles, plywood etc along with petrol hikes have all placed the policy makers in a dilemma as on one hand, they need to tighten the monetary policy to curb inflation and on the other hand, they also don’t want to affect the economic growth since economy is in the recovery phase after the credit crisis. “We had to control credit demand, especially unproductive demand has to be curtailed”, said KC Chakrabarty, Deputy Governor of RBI. That means, demand which is leading to price hikes has to be checked.

As a result, the reverse repo is raised from 3.75% to 4% and the repo rate from 5.25% to 5.5% (source: RBI website).This Thursday i.e. July 1 2010 saw a new regime in banking system with BPLR shifted to base rate policy. The base rate fixed at 7% - 8.75% with a view to have a transparent banking system, as said by the Chairman, OP Bhatt, SBI “The base rate will be transparent”, while the CRR remains at 6%.

The existing Benchmark prime lending rate system led to unequal distribution of policy rates to the customers. In BPLR system, the banks could also lend to the customers at a rate below than BPLR, in some cases like lending to large corporations, housing loans etc. As a result some sections were being benefitted at the expense of others i.e. housing & corporates were being benefitted since they are the credit-worthy customers of banks so were getting loans at a lower rate than the small retail investors. Hence, the whole system was not transparent as well as the monetary policy didn’t seem to be that effective as it was proposed. Hence, fixing a base rate for banks in the range 7% - 8.75% aims to have an effective monetary system as the banks won’t be able to lend below 7% even to the large corporations.

This could be the right time for the policy actions as waiting more could lead to more spiraling inflationary pressures.

Wait & watch for the July 27 policy review!!!!!!!


Archana Pillai said...

Can somebody elaborate as to how fixing a base rate range will improve monetary policy effectiveness? Please think of how the transmission mechanism will work in the money market?

neha said...

Fixing a base rate will enhance the efficiency of the monetary policy. It has been normally observed that when the central bank increases the policy rates the banks would also increase the lending rates to reflect an upward move.
However, when the policy rates go down the banks usually do not pass on the benefits to the public as a result the changes do not trickle down to the public and the policy gets restricted to the banks only. This is often known as Downward stickiness or Rigidity.

Normally when the bank reduces the repo and he reverse repo it targets at an increased money supply which does not happen since banks are reluctant to reduce the lending rates and hence the investments do not increase as expected by the central bank and the output growth doesn't take place to that extent.

Base rates are arrived after taking into account the cost of deposits and the cost of keeping aside cash to meet CRR and SLR requirements, it will ensure that banks align their lending rates with policy rate changes.Hence with a change in the policy rates the lending rates at the bank's end will change in sync and hence the growth will move more in tandem with the expectation of the central bank.

Nilesh said...

One of the positive point with the base rate is that the calculation of base rate is left to banks. A bank can calculate the cost of deposits taking 3months depoits, 6months deposits or any other deposits. This will encourage the competition among the banks which may be beneficial for the customers

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