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A New Growth Consensus?
The Reserve Bank of India and the government are taking contradictory approaches on liquidity and interest rates. The one eases liquidity but keeps interest rates high, the other promotes debt-financed consumption and pushes for cheaper consumer credit. This seems to be a new growth strategy based on a combination of liquidity infusion and interest rate reduction for consumer loans. But is this prudent? What of the fragility of the financial sector?
A series of apparently contradictory trends and measures point to a dangerous new consensus on the functional role of banks in India. To start with, in his first monetary policy review after assuming office, Reserve Bank of India (RBI) governor Raghuram Rajan decided to run with the hare and hunt with the hounds. He disappointed those who were expecting a cut in interest rates, by hiking the repo rate, arguing that the battle against inflation had not been won.
On the other hand, in what appeared to be a minor concession to those arguing that easy and inexpensive liquidity was needed to boost demand and flagging growth, he chose to lower the interest rate on the RBI’s marginal standing facility (MSF), established in 2011, under which banks can borrow funds at a rate linked to but set higher than the repo. The September 2013 Mid-Quarter Review of Monetary Policy reduced the earlier 2 percentage point differential between the MSF rate and repo rate by 75 basis points (bps) to 9.5%. The consequent ability of the banks to obtain funds at a lower cost without collateral was seen as a measure aimed at boosting banking sector liquidity.
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