Home > Money > Budget > Budget News & Analysis MARCH 1, 2002 | 17:20 IST    Feedback 


     
Interviews
Business Headlines
Corporate Headlines
Columns


 Portfolio Tracker
 

  My Portfolio

The Union Budget 2001-02
Economic Survey 2000-01
Exim Policy 2001-02
Credit Policy 2001-02
Railway Budget 2001-02
Budget Tutorial
Budget Process
Budget 2000-01
Budget 1999-2000
 



Large deficit hinders move to softer rates

India's move to link rates on huge state-run savings schemes to gilt yields will provide flexibility to the interest structure, but tighter fiscal discipline is the key element required to drive rates down.

In its Budget on Thursday, India estimated that its fiscal deficit for the year ending March 2002 will be 5.7 per cent of GDP, and for the next year 5.3 per cent, disappointing economists and rating agencies.

"To really bring down interest rates, you have to bring down the deficit. There are no two ways about that," said Ajit Ranade, chief economist at ABN Amro Bank.

"So much money is spent unproductively without creating new assets, which is very inefficient."

India announced in the Budget it was linking the interest on public savings schemes to central bond yields, which, under current market conditions, roughly spells a reduction of around 50 basis points.

Small savings -- a popular long-term retail option -- accounted for nearly 13.8 per cent of household financial savings in 1998-99 (April-March), latest published data showed.

MORE FLEXIBILITY

The move reduces distortions in the interest rates structure and levels the playing field for the range of borrowers vying for small savers' money, analysts said.

"When some rates are fixed and some market determined, there is scope for the gap between the two to widen, leaving some borrowers better positioned to attract savings, forcing others to borrow at artificially higher or lower rates," Ranade said.

And, as banks compete with these schemes, they will be able to price deposit and loans more efficiently.

The impact of a fixed regime was clearly visible in 2001 when India followed an easy monetary policy.

While the benchmark 10-year central bond yield tumbled 300 basis points, major banks' long-term deposit rates slid just 100-175 basis points, squeezing their earnings.

Global rating agency Standard & Poor's welcomed the move.

"It is a step forward as interest rates should always be dictated by the market rather than the government," said Takahira Ogawa, S&P's Asia-Pacific sovereign ratings director.

Moreover, a beneficiary of softer small savings rate is the government, whose interest payments comes down, he added.

FISCAL DISCIPLINE KEY

In recent years, borrowings have accounted for nearly 30 per cent of the government's receipts and India has spent almost half the total funds raised on debt servicing, defence and subsidies, which are unproductive.

"The huge borrowing programme puts constraint to some degree of freedom for interest rates manoeuverability," Reserve Bank of India Deputy Governor Y V Reddy told reporters on Thursday.

Suresh Soni, assistant vice president at Pioneer ITI AMC Ltd said: "Sluggish economic conditions and lower inflation notwithstanding, the country's huge deficits and market borrowing sustains an upward pressure on interest rates."

Other factors have also kept the cost of funds high.

India, being a developing economy, is deficient in capital. Moreover, Soni added its banking system has a substantial bad loan overhang apart from other operational inefficiencies, such as uneconomical branches and huge staff.

India followed an easing bias in 2001 with the central bank cutting its benchmark bank rate by a total of 150 basis points to 6.5 per cent. But further cuts will be limited.

"I think we are close to the bottom of the easing cycle," Soni said. "The bank rate may be cut by another 50 basis points but not much beyond that."

Reuters

YOU MAY ALSO WANT TO READ:
The Rediff Budget Special
The Rail Budget 2002-03
The Economic Survey 2001-02
More Budget Stories
Money


 
  © 1996 - 2002 rediff.com India Limited. All Rights Reserved.