Why Reserve Bank of India should cut CRR levels – The Financial Express

Will free up cash reserves and create room for lower rates.

India’s investment cycle has been in a trough for several years now. And it could take at least a couple of years more for it to crawl out of that trough. Apart from the fact that capacities in most sectors seem sufficient for some time, there is a shortage of equity capital and a good many companies remain over-leveraged. But even if these factors improve, real interest rates in the economy are high. While a drop in the real rate is unlikely to prompt promoters to add capacities, it will make a difference at the margin and that is not to be sneezed at given the pitifully small greenfield investments that the private sector is making today.

Real rates are unlikely to fall sharply in the near term because inflation is expected to remain benign with just a small rise being pencilled in. Ideally, households should have been spurred into saving more at these elevated real rates of around 5% but the trends are otherwise. The pace of such savings has been stagnant over the last few years with the growth rate having dropped to 17.2% in 2017-18, from a robust 22.5% in 2012-13. The net financial savings rate in 2017-18 was just 6.6% compared with 7.4% in 2012-13. The sharp drop in the growth rate is not so hard to understand. Consumers have been spending more as society turns more aspirational and, in fact, many are open to borrowing to make the purchases—that is why there has been such a large increase in household liabilities. Also, in the absence of enough jobs and, more importantly, enough well-paying jobs, the ability to save has been smaller.

On the other hand private corporate savings, while not having risen substantially, have been steady over the past few years after a sharp uptick between 2004-05 and 2014-15. To be able to entice companies to borrow to expand capacities, banks need to be able to keep loan rates at affordable levels. However, with deposits growing at a much slower pace than loans—around 9.5-10% compared with 14.5-15% for loans—they are unable to lower deposit rates and that is driving up the cost of funds. Strategists at Kotak Institutional Equities have suggested that RBI should trim the Cash Reserve Ratio (CRR) to manage the rising gap between the high credit growth and low deposit growth given a cut in the policy rates may not help much. Indeed, the transmission of a cut in the repo to loan rates has been very poor over the last few years, the key reason being the relatively high cost of deposits. Also, banks are holding more liquid assets—gilts—than they need to give them a cushion. A CRR cut would free up cash and create some room to lend at lower rates.

via Why Reserve Bank of India should cut CRR levels – The Financial Express

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