The US Federal Reserve left interest rates unchanged last week. The Reserve Bank of India did likewise, but it raised the Cash Reserve Ratio (CRR, or the money banks have to keep aside on their deposits) by 50 basis points or half per cent.
Many people who see these headlines in papers donâ€™t follow the news in detail, because they think it doesnâ€™t affect them. As one reader was heard saying: â€œI donâ€™t understand why US Federal Reserveâ€™s action would affect interest rates in Indiaâ€.
He felt that often the RBIâ€™s actions made little sense. The RBI didnâ€™t change the rates, and yet deposit rates are coming down.
If these sentiments are shared then one may be in for a surprise. It also affects the stock market, the growth rate of the economy, and the flow of foreign investment into the country, among other things. The Federal Reserveâ€™s moves impact economies around the world, because the US is the worldâ€™s largest economy, and the biggest trading partner of many countries including India.
The RBI raised its key short-term rate, the reverse repo rate, several times in the past year. It did this because it wanted to rein in the inflationary pressure in the economy. It also wanted to curb unbridled growth in some pockets of the economy, like real estate and bank credit off take.
The measures seem to have had the desired effect. The RBI noted in its latest policy review that the bank credit has been moderated because of hardening interest rates. It also noted that inflation had fallen to a more comfortable level.
There was too much money in the banking system, which was pushing down short-term interest rates to very low levels. The call money rateâ€”the interest rate for overnight funds fell to zero. The CRR, hike took Rs 16,000 crore out of the banking system and reduced the excessive liquidity in the system.
From the above the impact of central banksâ€™ policy changes can be visualized even by people who may not be financial specialists but have a common manâ€™s knowledge of finances.
The Reserve Bank of Indiaâ€™s decision to hold key rates in the first quarterly review of its annual policy signals that frequent hikes in floating rate may be coming to a halt, at least. Loan rates to remain steady and the impact is â€˜bull runâ€™ to continue for now.
However, rates are unlikely to drop anytime soon. A 50-basis-point hike in the cash reserve ratio (the money banks must set aside on deposits) is likely to keep rates steady in the near term. Investors in stocks can expect the good stock markets to continue for a while.
The RBI in its notification recently, advised banks to adhere to the â€˜Fair Practices Codeâ€™ and make charges â€˜reasonableâ€™. As per the central bankâ€™s directive, though the decision to stipulate charges is at the discretion of the individual banks, they need to ensure that these charges are consistent with the cost of providing the services.
Moreover, all banks are required to display and regularly update the details of various service charges on their website as well as at their branches, in a pre-defined format as finalized by the central bank. This will enable customers to have a greater insight on the costs involved when they avail of the various services provided by the banks.
The RBI has also extended the Banking Ombudsman Scheme (set up to address bank customersâ€™ complaints), to include deficiencies in providing services assured by banks and the levying of charges without prior intimation to the customers. So, if you are not satisfied in terms of the quality or the charges while availing a particular service, you can file a complaint with central bank under this scheme.
The conclusion is when a countryâ€™s monetary authority increases or decreases one of its policy rates, it has a profound impact on the countryâ€™s entire economy. It affects interest rates on deposits as well as lending.