The Liquidity problem...

The debate in the air that the economy has a liquidity-deficit owes a lot of attention because it would ultimately hinge on the credit cost, investment and higher growth rate, closest to the potential even when the policy rates are on a downtrend. The central bank has reduced repo-rate cumulatively by 1.25% or 125 basis-points but the commercial banks have passed only a 60 basis-points which failed to give a strike in terms of credit take-off and growth. The commercial banks are demanding more liquidity to pass on the policy rate transmission because that would increase the scale by adjusting the rates lower and give investment a fillip. Lower interest rates would increase the demand for investment, but the banks are insisting on higher rates which are holding the recovery of the economy back. In one way it is totally equivalent to the demand for lower policy rates. Banks put liquidity-deficit as an answer to higher rates even when the policy rates have gone down and the RBI is in the midst of rate-cut. Policy rate cuts also mean more liquidity; it means the commercial banks can borrow at lower rates, besides their own deposits. If banks can borrow lower they should pass on the benefit to the investor so that they may increase spending. Moreover, lower borrowing cost would help the banks to increase their market share. Lower borrowing cost might increase the scale. The banks are looking at the RBI for more liquidity but the Governor is clueless that the situation rose even after the rate cuts. However, the commercial banks always persist for higher rates. Bond traders also demand more liquidity and lower yields because that increases bond-prices. Commercial banks should revaluate their strategy. RBI is cutting rates and lower policy rates also mean higher liquidity.