monetary transmission in india : why is it important and why hasn ’ t it worked well? - dr. viral v acharya, deputy governor, reserve bank of india inaugural aveek guha memorial lecture thursday 16th november 2017 homi bhabha auditorium tata institute of fundamental research ( tifr ) when i travel from my residence in vile parle ( w ) to the reserve bank of india central office in fort, i pass each way kenilworth – the birth place of late homi jehangir bhabha. it is a good way to start and end the day, being reminded not just of his immense intellect but also of his deep sense of service to india. i am thus grateful to professor dipan ghosh, who was the dean of students during my time at iit bombay, for inviting me to speak today in the homi bhabha auditorium, and to dr subhendu guha, for having endowed this lecture series at the tata institute of fundamental research ( tifr ) in memory of his dear son, aveek guha. “ aveek, ” a beautiful bengali name meaning “ fearless ”, is exactly how all research needs to be, taking on seemingly insurmountable challenges, fighting it out with grit, and along the way, dissecting, reflecting, and distilling truth to its essence until it is unearthed in some recognizable form from beneath its scratchy exterior. the tifr is a daunting proposition for any researcher to speak at. i hope that i can progress some way towards meeting its highest standards in the form of this talk, by raising an issue that is germane to all of us in today ’ s forum and that is worthy of being tackled in due course – that of, monetary transmission in india : why is it important and why hasn ’ t it worked well? let me start with some technical jargon and then explain from first principles the part of it i wish to focus on. with the amendment of the reserve bank of india act in 2016, the “ primary objective of the monetary policy is to maintain price stability while keeping in mind the objective of growth ”. the monetary policy committee ( mpc ) constituted under the amended rbi act is mandated to determine the policy repo rate to achieve the specified medium - term inflation target of 4 per cent, within a band of + / - 2 per cent. for the reserve bank to achieve its mandate effectively, it is extremely important that an economic process referred to

offset by some banks by a simultaneous increase in the spread in the form of business strategy premium ostensibly to reduce the passthrough to lending rates ; ( ii ) there was no documentation of the rationale for fixing business strategy premium for various sectors ; ( iii ) many banks did not have a board approved policy for working out the components of spread charged to a customer ; ( iv ) some banks did not have any methodology for computing the spread, which was merely treated as a residual arrived at by deducting the mclr from the actual prevailing lending rate ; and ( v ) the credit risk element was not applied based on the credit rating of the borrower concerned, but on the historically observed probability of default ( pd ) and loss given default ( lgd ) of the credit portfolio / sector concerned. maturity of three years and above ( table - 2 ), implying their rates get reset infrequently and with significant lags to policy rate changes. while the banks ’ marginal cost of funds may drop quickly with a cut in fresh deposit rates, the average cost of deposits comes down rather slowly, which weakens the transmission, especially in the case of the base rate system. table - 2 : maturity profile of term deposits of scheduled commercial banks ( % share in total term deposits ) up to 6 - month 5 years 91 - days to to 1 1 year to 2 years to 3 years to and days 6 month year 2 years 3 years 5 years above 13. 9 10. 5 15. 0 23. 4 10. 7 18. 1 8. 4 6. 9 8. 4 13. 7 37. 9 12. 3 12. 4 8. 3 7. 5 4. 1 12. 6 40. 4 10. 1 11. 4 13. 9 7. 2 4. 0 9. 2 43. 3 10. 6 11. 8 14. 0 source : handbook of statistics on the indian economy, rbi. endmarch what is often not recognised is the large access our banks have to low cost current and savings account ( casa ) funds. casa funds constitute about 40 per cent of aggregate bank deposits with the share of saving deposits at around 31 per cent. importantly, banks are free to decide saving deposit interest rates since october 2011, but until recently, most of the banks chose to leave the saving deposit rate unchanged, ignoring completely monetary policy signals. for instance, the major banks kept their saving deposit rate unchanged at 4 per cent between october 2011 and july 2017