Monetary Policy

Why politicians love paper money

3D chrome Dollar symbolMoney makes money, and the more money that money makes, makes more money—Benjamin Franklin


John Maynard Keynes was the most influential economist of the twentieth century. Keynes really came into his own in 1936, when his magnum opus The General Theory of Employment, Interest and Money was published.
One of the core points of the book was that when it came to thrift or saving, the economics of the individual differed from the economics of the entire system. For an individual to save by cutting down on expenditure made tremendous sense. But when a society, as a whole, began to save more, there was a problem.
This was because the expenditure of one person was the income for another. Hence, when expenditure began to go down, incomes would fall too, leading to a further reduction in expenditure. And so the cycle would continue. The aggregate demand of a society as a whole would fall in the end, leading to either lower prices or lower production or both, thus impeding economic growth and causing economic contraction.
As per Keynes, the way out of this situation was for someone to spend more. Citizens and businesses were not willing to spend more, given the state of the economy. So, the only way out of this situation was for the government to spend more on public works and other programs. This would act as a stimulus and thus cure the recession.
This has been standard prescription given by economists when countries are not doing well. Having said that the basic idea put forward by Keynes had been known for a very long time. Even Roman kings had practised it.
As Kabir Sehgal writes in Coined—The Rich Life of Money and How Its History Has Shaped Us: “Julius Caesar left his stamp on Roman monetary history by using the gold treasure he pillaged from Gaul to increase the quantity of the aureus in circulation…These new coins helped Rome cope with a financial crisis of 49BC.” So, even Julius Caesar had used Keynes’ prescription of increasing government spending during recessionary times and thus helped revive the economy.
Caesar’s successor Augustus followed the same prescription in order to revive the Roman economy when it was suffering from a depression, during the course of his rule. As Sehgal writes: “Augustus used loot captured from Egypt to spend lavishly on civil projects and enhanced welfare programs…In time…the economy recovered.”
Interestingly, the rulers that followed Julius and Augustus, followed their model. One such ruler was Nero who ruled Rome between AD 54 and AD 68 and had to face a depression in AD 62. In AD 64, a fire blazed through Rome and this created further problems. But Nero got through this by increasing “food subsidies for the public” and “spending on civil projects like canals”.
But along with following the Keynesian model, Nero did something else as well. He started reducing the quantity of metal in the Roman coins. Nero reduced the silver content of denarius (a silver coin) by 10%. He also reduced the gold content of the aureus by 10 percent in AD 64. By reducing the metal content in coins Nero was able to produce more coins. In the modern sense, he was thus able to increase money supply by around 7%.
What was the idea behind this debasement of metallic money? “The story goes that with more money flowing through the economy, prices will rise to reflect the reduced value of the currency, which will spur individuals and businesses to spend now rather than later, leading to a bump in economic activity,” writes Sehgal.
Nero was the not the first ruler to practice this strategy. Neither was he the last one. This is a practise that has been regularly resorted to by kings, queens, dictators, general secretaries, and politicians ever since.
In fact, Nero couldn’t have gone about it as well as politicians and central bankers do, in this day and age. The reason for this lies in the fact that during Nero’s time Rome used gold and silver coins as money. As Sehgal writes: “Nero was unable to affect uniformly his entire currency at once. When he issued a new batch of debased coins[i.e. coins with lower metal content] there were still high-grade coins{i.e. the coins that had been issued earlier and had a higher amount of metal content in them] in circulation. The value of these high-grade coins would appreciate, yet it would take time for them to be hoarded and removed from circulation.” They would be hoarded because they had more metal in them than the new coins.
But with paper money there are no such problems. When a central bank issues more paper money it “adjusts the overall money supply” and “affects the value of all notes simultaneously”. “Today it’s still common practice for central banks to adjust the supply of money to abet political goals,” writes Sehgal.
Take the case of Bank of Japan—the Japanese central bank is mandated to print 80 trillion yen annually so that it can create some inflation in Japan and get people to spend money (as explained above) and in the process create some economic growth. The idea also is to drive down the value of the yen against other currencies so that Japanese exports pick up. A paper money system gives the government and the central bank this kind of flexibility. This is something that would not be easily possible in a metallic based system. In order to flood the financial system with more gold or more silver, more gold or silver would be required. Unlike paper money, metallic money cannot be created out of thin air.
Also, history has shown that debasement of currency leads to inflation as more and more money chases the same amount of goods and services. And inflation benefits borrowers as they repay money they had borrowed with money that is less valuable than it was before. Further, governments run by politicians are themselves big borrowers. Hence, inflation ends up benefiting governments as well.
It is much easier to create inflation with a paper money system than with metal based currencies. In fact, a few years back I spoke to Russell Napier of CLSA who made a very interesting point: “The history of the paper currency system, or the fiat currency system is really the history of democracy… Within the metal currency, there was very limited ability for elected governments to manipulate that currency. And I know this is why people with savings and people with money like the gold standard. They like it because it reduces the ability of politicians to play around with the quantity of money. But we have to remember that most people don’t have savings. They don’t have capital. And that’s why we got the paper currency in the first place. It was to allow the democracies. Democracy will always turn toward paper currency and unless you see the destruction of democracy in the developed world, and I do not see that, we will stay with paper currencies and not return to metallic currencies or metallic based currencies.”
And this best explains why politicians love paper money.

The column originally appeared on The Daily Reckoning on April 16, 2015

Rajan doesn’t have much scope to cut repo rate further

ARTS RAJAN
The Reserve Bank of India(RBI) governor Raghuram Rajan presented the first monetary policy for this financial year, yesterday. He kept the repo rate at 7.5%, after having cut it by 25 basis points(one basis point is one hundredth of a percentage) each in January and March, earlier this year. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.
Rajan further said that “going forward, the accommodative stance of monetary policy will be maintained.” This meant that the RBI would continue to bring down the repo rate subject to a few factors.
First, Rajan said that the banks had not passed on the earlier cuts in the repo rate to the end consumers by cutting their base rates or the minimum interest rate a bank charges its customers. Without this happening there is no point in the RBI cutting the repo rate. (In a column earlier this month I had explained why banks are not cutting their base rates. You can read it here).
Secondly Rajan said that “ developments in sectoral prices, especially those of food, will be monitored, as will the effects of recent weather disturbances and the likely strength of the monsoon.” The northern part of the country has seen unseasonal rains and that has led to rabi cop being damaged. This is expected to push food prices up. Governor Rajan wants to monitor this for a while and see how it pans out, before deciding to cut the repo rate further.
Third, the RBI is watching what the government is doing on the policy front to “ to unclog the supply response so as to make available key inputs such as power and land.” And fourth, the Rajan led RBI is watching “for signs of normalisation of the US monetary policy”. This essentially means that the RBI is closely observing as to when the Federal Reserve of the United States, will start raising interest rates in the United States.
Depending on how these factors play out, the RBI will decide if and when to cut the repo rate further. But the question is how much room does the RBI have to cut the repo rate any further? Rajan has often said in the past that he wants to maintain a real interest rate level of 1.5-2%. Real interest is essentially the difference between the rate of interest (in this case the repo rate) and the rate of inflation.
The current repo rate at which the RBI lends stands at 7.5%. In the monetary policy statement released yesterday RBI said: “The Reserve Bank will stay focussed on ensuring that the economy disinflates gradually and durably, with CPI inflation targeted at 6 per cent by January 2016.”
If we consider the rate of inflation of 6% and add a real rate of interest of 1.75%(the average of 1.5% and 2%) to it, we get 7.75%. The current repo rate is at 7.5%, which is 25 basis points lower than 7.75%.
What if, we consider the latest rate of inflation as measured by the consumer price index? For the month of February 2015, the inflation stood at 5.4%. If we add 1.75% to it, we get 7.15%, which is lower than the prevailing repo rate of 7.5%. If we add 1.5% to the prevailing rate of inflation, we get 6.9%, which is sixty basis points lower than the prevailing repo rate of 7.5%.
What both these calculations clearly tell us is that there is not much scope for the RBI to cut the repo rate further. At best it can cut the repo rate by another 50 basis points. This is assuming that Rajan maintains his previous stance of maintaining a real interest rate level of 1.5-2%.
As of now there is no evidence to the contrary. As Rajan had said in September 2014: “Have we artificially kept the real rate of interest somehow below what should be the appropriate natural rate of interest today and created bad investment that is not the most appropriate for the economy?”
This is a very important statement and needs to be dealt with in some detail. Look at the accompanying chart.
The government of India between 2007-2008 and 2013-2014 was able raise money at a much lower rate of interest than the prevailing inflation. The red line which represent the estimated average cost of public debt(i.e. Interest paid on government borrowings) has been below the green line which represents the consumer price inflation, since around 2007-2008.
And if the government could raise money at a rate of interest below the rate of inflation, banks couldn’t have been far behind. Hence, the interest offered on fixed deposits by banks and other forms of fixed income investments was also lower than the rate of inflation, between 2007-2008 and 2013-2014.
This essentially ensured that household financial savings fell from 12% of the GDP in 2009-2010 to 7.2% of the GDP in 2013-2014. As the rate of interest on bank fixed deposits was lower than the rate of inflation, people moved their money into real estate and gold. Household financial savings is essentially the money invested by individuals in fixed deposits, small savings scheme, mutual funds, shares, insurance etc.
If the household financial savings rate has to be rebuilt, the rate of interest on offer to depositors has to be significantly greater than the rate of inflation. Given this, a real rate of interest of 1.5-2% that Rajan has talked about makes immense sense, if household financial savings need to be rebuilt all over again.
And if a real interest rate of 1.5-2% has to be maintained then the RBI doesn’t have much scope to cut the repo rate further—around 50 basis points more.

The column originally appeared on The Daily Reckoning on April 8, 2015 

RBI policy: Raghuram Rajan’s rate cuts have been useless till now. Here’s why

ARTS RAJAN
I like to often quote the American baseball coach Yogi Berra in pieces that I write, given that a lot of what he has said makes so much sense. One of Berra’s most famous quotes (which I have also used on numerous occasions) is: “In theory there is no difference between theory and practice. In practice there is.”
Raghuram Rajan, the governor of the Reserve Bank of India(RBI), more or less stated the same in the first monetary policy of this financial year, which was released today. Rajan decided to keep the repo rate at 7.5%. He has cut the repo rate twice this year, first in January and then in March. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loans.
But these cuts amounting to a total of 50 basis points (one basis point is one hundredth of a percentage) have not been passed by the banks. A recent Bloomberg newsreport pointed out that 43 out of the 47 scheduled commercial banks haven’t cut their base rates or the minimum interest rate a bank charges its customers. This means that EMIs on loans will continue to remain high.
Theoretically one expects banks to cut their lending rates after the RBI has cut its repo rate twice. But that hasn’t happened. As Rajan put it in the monetary policy statement: “Transmission of policy rates to lending rates has not taken place so far despite weak credit off take and the front loading of two rate cuts.” Offering this as a reason, Rajan and the RBI decided to maintain the repo rate at 7.5% in the monetary policy announced today.
Lending by banks has grown by a minuscule 9.5% in the last one year, data from the RBI points out. In comparison, the growth in deposits collected by banks has been at 11.4%. What also needs to be taken into account here is that the deposit growth has been on a higher base.
Hence, deposits have been growing at a much faster rate than loans. Theoretically, this should have led to banks cutting interest rates so that more people would borrow. But that hasn’t happened. There are multiple reasons for the same.
In order to cut their lending rates, banks need to reduce their base rate or the minimum interest rate that a bank charges to its customers. When a bank cuts its base rate, the interest rates that it charges on all its loans, fall. But the interest that it pays on its deposits do not work in the same way.
When a bank cuts the interest rate on its fixed deposit, only fixed deposits issued after the cut, get paid a lower rate of interest. The fixed deposits issued before the cut continue to be paid a higher rate of interest. While the interest a bank earns on its loans is floating, the interest it has to pay on its deposits is not. Hence, banks are reluctant to cut their lending rates even though the RBI has indicated to them very clearly that it is time that they started to do so.
Over and above this, most public sector banks have huge bad loans to deal with. And cutting interest rates would mean taking the risk of lower profits, hence, status quo is the preferred way.
Further, it might be worth pointing out here that it takes time for the impact of the RBI rate cuts to trickle down. A recent report by the International Monetary Fund (IMF) makes this point: “Pass-through to deposit and lending rates is relatively slow and the deposit rate adjusts more quickly to monetary policy changes than does the lending rate.”
The report further points out that it takes around 18.8 months (a little over one and a half years) for the lending rates to change. The deposit rates change in 9.5 months. Once these data points are taken into account it is easy to conclude that the two repo rate cuts by the RBI in January and March 2015, will take time to trickle down.
That just about answers the question why the repo rate cuts by the RBI haven’t benefited the end consumers. The next question I try and answer in this piece is what will it take for the RBI to cut the repo rate again?
As Rajan said in the press conference after the announcement of the monetary policy: “You shouldn’t expect direction to change in future.” What he was basically saying here is that the RBI remains on course to keep bringing down the repo rate in the days to come.
And what will it take for the central bank to do that? The monetary policy statement has the answer: “The Reserve Bank will await the transmission by banks of its front-loaded rate reductions in January and February into their lending rates. Second, developments in sectoral prices, especially those of food, will be monitored, as will the effects of recent weather disturbances and the likely strength of the monsoon, as the Reserve Bank stays vigilant to any threats to the disinflation that is underway.”
Unseasonal rains in North India have damaged a lot of rabi crop. A March 27, 2015, press release by the ministry of agriculture points out: “As per the latest reports received from States, the area under rabi rice as on today stands at 39.43 lakh hectare as compared to 43.55 lakh hectare at this time last year. Total area under rabi rice and summer crops moves to 52.20 lakh hectare as compared to 55.28 lakh hectare at this time last year.” Pulse is another important rabi crop.
This crop damage is expected to push up food prices to some extent. An increase in the price of rice can be curtailed if the government chooses to release some of the huge stock of rice that it has. As on March 1, 2015, the government had a wheat stock of 195 lakh tonnes.
What will also help curtail food inflation is the fact that rural wage inflation has been on its way down for a while now. One of the major reasons that food prices were high between 2008 and 2013 was the rapid increase in rural wages.
As Chetan Ahya and Upasana Chachra of Morgan Stanley point out in a recent research note: “In the 2008-13 period, we believe intervention in the labour market artificially pushed rural wage growth to 18-20% year on year. With wages accounting for 50% of operating costs in food production and higher income growth into hands of rural labour without matching the increase in productivity, the rapid rise in wage growth resulted in persistently high inflation.”
But this increase is now a thing of the past. “The good news is that rural wage growth has been on a decelerating trend over the past 13 months as government intervention in rural labour markets has reduced. Since Jan-14, rural wage growth has decelerated at a quick pace and currently averages 6.2% for the 12 months ending Jan-15, compared with 16% for the 12 months ending Jan-14. Moreover, the latest data shows rural wage growth at 5.5% in Jan-15 – near a 9- year low,” the report points out.
This will ensure that food inflation spikes will be controlled in the days to come. And that should give some more space to Rajan to cut the repo rate.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Firstpost on April 7, 2015

Why money printing hasn’t led to inflation

bubble

In response to the last column Janet Yellen’s excuses for not raising interest rates will keep coming a reader wrote in asking why all the money printing that has happened since September 2008 in the aftermath of the financial crisis, hasn’t led to inflation.
In this column I try and answer that question. Economist John Mauldin estimates that central banks have printed $7-8 trillion since the start of the financial crisis. In another estimate, author and financial derivatives expert Satyajit Das points out balance sheets of the major central banks have expanded from around $5 trillion prior to 2007–2008 to over $18 trillion.
The central banks printed this money (or rather created it digitally through a computer entry) and used it to buy government and private bonds and this has led to the expansion of their balance sheets. In fact, the amount of money pumped into the financial systems of the developing countries has been so huge that it would be suffice to purchase a large flat-screen TV for every single individual in the world, points out Das.
By buying bonds, central banks pumped the printed money into the financial system. This was done primarily to ensure that with so much money floating around, the interest rates would continue to remain low. At low interest rates people would borrow and spend. This would help businesses grow and in turn help the moribund economies of the developing countries.
But money printing should have led to inflation as a greater amount of money chased the same amount of goods and services. Milton Friedman, the most famous economist of the second half of the twentieth century, wrote in Money Mischief – Episodes in Monetary History: “The recognition that substantial inflation is always and everywhere a monetary phenomenon is only the beginning of an understanding of the cause and cure of inflation…Inflation occurs when the quantity of money rises appreciably more rapidly than output, and the more rapid the rise in the quantity of money per unit of output, the greater the rate of inflation. There is probably no other proposition in economics that is as well established as this one.”
Nevertheless that did not happen. Inflation remains very close to 0% in large parts of the developed world. Why is that the case? Japanese economist Richard Koo perhaps has an answer. Koo calls the current state of affairs in the United States as well as Europe a balance-sheet recession. Japan had seen a huge real estate as well as stock market bubble in the 1980s. In fact, such was the confidence in the high home prices continuing that by the end of the 1980s Japanese home buyers were even taking out 100-year home loans or mortgages.
As Stephen D. King writes in When the Money Runs Out: “By the end of 1980s, it was not unusual to find Japanese home buyers taking out 100-year mortgages, happy, it seems, to pass the burden on to their children and even their grandchildren. Creditors, meanwhile, naturally assumed the next generation would repay even if, in some cases, the offspring were not more than a twinkle in their parents’ eyes. Why worry? After all, land prices, it seemed, only went up.”
That did not turn out to be the case. The stock market bubble started bursting in December 1989, and the real estate bubble followed. Koo feels the current Western situation is very similar to that seen in Japan in 1990, when both the stock market bubble and the real estate bubble had burst.
What does this imply in the current scheme of things? People in the developed world had taken on huge loans to buy homes in the hope that prices would continue to go up in perpetuity. But that wasn’t to be. Once the bubble burst, housing prices crashed. This meant the asset (i.e., homes) people had bought by taking on loans had lost value, but the value of the loans continued to remain the same. Hence, people needed to repair their individual balance sheets by increasing savings and paying back debt. This act of deleveraging, or reducing debt, brought down aggregate demand and threw the economies in the developed countries into a balance-sheet recession.
A similar thing happened in Japan as well in the 1990s. In the aftermath of the bubbles bursting the Japanese carried out quantitative easing where they bought bonds in the hope of maintaining low interest rates, so that people would borrow and spend. Nevertheless, that did not happen because people were busy paying off their old loans.
A similar dynamic is at play in the developed countries at this point of time. Hence, people are not borrowing and spending at the same rate as they are expected to, because they are busy paying off old loans. As Tim Harford explains in The Undercover Economist Strikes Back: “Printing money creates inflation only if people want to spend the money right away. And perhaps they don’t.”
While, there has been no inflation in the conventional sense of the term, what the world is seeing instead is asset price inflation. A lot of the printed money has been borrowed at very low interest rates by institutional investors and has found its way into financial markets all over the world.
Other than this money briefly went into gold and then into other physical assets as well. As Gary Dugan of RBS told me in an interview sometime back: “Gold went up as much as it did in its last wave. If you look at Sotheby’s and Christie’s, in the art market, they are doing extremely well. The same is true about the property market. Places which are in the middle of a jungle in Africa, there prices have gone upto $100,000 an acre. Why? There is no communication. No power lines.”
This explains why there is no inflation but there is asset price inflation for sure. To conclude, it is important to understand something that Harford writes: “The Federal Reserve(and other central banks) spent decades … acquiring a reputation for waging a ruthless, unending war against inflation. That reputation is so powerful and so valuable that people naturally wonder whether the Federal Reserve really would encourage inflation once the slump ended. The trouble is that if people don’t believe that threat, they won’t start spending and the slump will continue.”

 

The column originally appeared on The Daily Reckoning on Mar 24, 2015

Why banks are not cutting interest rates

ARTS RAJAN
The Reserve Bank of India (RBI) presented its last monetary policy statement for this financial year, yesterday. It decided not to cut the repo rate which continues to be at 7.75%. The repo rate is the interest rate at which the RBI lends to banks and is expected to act as a sort of a benchmark to the interest rates at which banks carry out their business.
The RBI deciding not to cut the repo rate was largely around expected lines. I had said so clearly in my column dated January 16, 2015. The RBI had cut the repo rate by 25 basis points (one basis point is one hundredth of a percentage) a day earlier, on January 15, 2015.
There was a straightforward reason for this—the RBI had said in the statement released on January 15, that: “Key to further easing are data that confirm continuing disinflationary pressures.” Between January 15 and February 3 no new inflation data has come out. Hence, there was no way that the RBI could figure out whether the fall in inflation (or what it calls disinflation) has continued. Given this, there was no way it could cut the repo rate, unless it chose to go against its own guidance.
The more important issue here is that despite the RBI cutting the repo rate on January 15, 2015, very few banks have acted on it and passed on the rate cut to their consumers. Reuters reports that only three out of India’s 45 commecial banks have cut their base lending rates since the RBI cut the repo rate last month. The base rate is the minimum interest rate a bank is allowed to charge to its customers.
This has happened in an environment where growth in bank loans has slowed down substantially. Every week the RBI puts out data regarding the total amount of loans given out by banks. As on January 9, 2015 (the latest such data available), the total lending by scheduled commercial banks had grown by 10.7% over a one year period. For the one year period ending January 10, 2014, the total lending by banks had grown by 14.8%. This clearly shows that the bank lending has slowed down considerably over the last one year.
In this scenario theoretically it would make sense for banks to cut their interest rate so that more people borrow. As Rajan put it while addressing a press conference yesterday: “To get that lending they will have to be more competitive, which means they will have to cut base rate. I am hopeful it is a matter of time before banks judge that they should pass it on.”
But as I have often explained in the past cutting interest rates does not always lead to more people borrowing because the fall in EMIs is almost negligible in most cases.
As John Kenneth Galbraith writes in The Affluent Society: “Consumer credit is ordinarily repaid in instalments, and one of the mathematical tricks of this type of repayment is that a very large increase in interest brings a very small increase in monthly payment.” And vice versa—a large cut in interest rate decreases the monthly payment by a very small amount. So interest rate cuts do not always lead to people borrowing more.
Hence, the banks run the risk of cutting the base rate and charging their existing customers a lower rate of interest and at the same time not gaining new customers. This will be a loss-making proposition for banks and given that only 3 out of the 45 scheduled commercial banks have cut their base rates since January 15, 2015.
Banks increase their lending rates very fast when the RBI raises the repo rate. But they take time to cut their lending rates particularly in a situation where the RBI has reversed its monetary policy stance and cut the repo rate after a long time.
As Crisil Research points out in a research note released yesterday: “Lending rates show upward flexibility during monetary tightening but downward rigidity during easing. Between 2002 and 2004, while the policy rate declined by 200 basis points, lending rates dropped by just 90-100 basis points. Conversely, in 2011-12, when the policy rate rose by 170 basis points, lending rates surged 150 basis points.”
So when the RBI is increasing the repo rate, banks typically tend to match that increase, but the vice versa is not true. “Lending and deposit rates also move in tandem in times of policy rate hikes, while the gap between them widens when rates fall. Base rates of banks have been steady around 10-10.25% over the last 18 months, while deposit rates started coming down in October 2014 by about 20- 25 basis points because of ample liquidity.,” points out Crisil Research.
This is something that Rajan also talked about yesterday, when he said: “Many [banks] have been relatively quick to cut their deposit rates, but not so quick to cut their lending rates, I presume some are hoping they can get the spread for a little more time to repair banks’ balance sheets.”
When a bank cuts the interest rate it pays on its fixed deposits and at the same time does not cut its lending rate, it earns what bankers call a greater spread. This essentially means more profit for the bank.
Rajan in his statement also talks about banks repairing their balance sheets. This is particularly in r reference to the bad loans of public sector banks. As the latest financial stability report released by the RBI in December 2014 points out: “PSBs[public sector banks] continued to record the highest level of stressed advances at 12.9 per cent of their total advances in September 2014 followed by private sector banks at 4.4 per cent.” The situation hasn’t really changed since then, if the latest quarterly results of public sector banks for the period October to December 2014 are anything to go by.
The stressed asset ratio is the sum of gross non performing assets plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate.
What this means in simple English is that for every Rs 100 given by Indian banks as a loan(a loan is an asset for a bank) nearly Rs 10.7 is in shaky territory. For public sector banks this number is even higher at Rs 12.9.
The public sector banks are hoping to recover some of these losses by cutting their deposit rates but staying put on their lending rates. And this leads to a situation where even though the RBI has cut the repo rate once, it hasn’t had much impact on the lending rates of banks. “High non performing assets curb the pace at which benefits of lower policy rate are passed on to borrowers. Data shows periods of high NPAs – such as between 2002 and 2004 (when NPAs were at 8.8% of gross advances) – are accompanied by weaker transmission of policy rate cuts. This time around, NPA levels are not as high as witnessed back then, but still remain in the zone of discomfort,” Crisil Research points out.
In this situation, banks will cut lending rates at a much slower pace than the pace at which the RBI cuts the repo rate.

(The column originally appeared on www.equitymaster.com as a part of The Daily Reckoning, on Feb 4, 2015)