What has happened is that because of the high proportion of term deposits in commercial banks' deposit portfolios, they are effectively stuck still paying high rates of interest on a significant part of the deposits. Meanwhile, depressed investment conditions and the fact that the prime borrowers now have access to capital from abroad in the form of GDRs, ADRs and ECBs have implied less demand for credit from the preferred borrowers. In the circumstances, banks are relying on increasing certain forms of high-value lending such as consumer credit, and on safe government securities which offer relatively high rates of return because the interest rates on most government debt remain high.
 
Therefore the process seems to be as much demand-driven as anything else, in terms of banks finding difficulty in identifying desired borrowers at the prevailing rates of interest. That is why bank holding of government securities has increased substantially in recent years, rising from 26 per cent of total deposits at the beginning of the decade to 34 per cent at the end of the decade. And, as Chart 9 shows, credit deposit ratios have fallen from the already low levels of the early 1990s, to abysmally low levels of just above 50 per cent.
Chart 9 >>
 
This is more than an interesting irony, given the reduction of the Statutory Liquidity Ratio as part of the financial reforms of the early 1990s. This measure was designed to free commercial banks from necessarily holding more than one-third of their assets in the form of government securities, since the SLR was lowered to 26 per cent in 1993. It turns out that the current position is that commercial banks are holding more than Rs. 100,000 crore as government securities. This amounts to 35 per cent of the deposits, which is well in excess of the minimum holding that is currently required, of 25 per cent. In fact it is the same as the level that existed prior to the financial reform measures !
 
At the time when they were first implemented, these financial liberalisation measures were widely described as working to increase the access of private borrowers to bank credit. Instead, what appears to have occurred is that banks are now voluntarily holding government securities (for which the government is paying much higher interest rates !) and credit to the private sector appears to have been further reduced in proportion to deposits. So, while this measure did operate to make borrowing more expensive for the Central Government and therefore increased its interest burden, it has certainly not led to greater access of the private sector to bank credit.
 
In this context, why then have interest rates not declined in real terms ? If banks are hard put to find desirable domestic borrowers in a context of domestic recession, and instead prefer to hold government securities, then why are real interest rates not driven down further ?
 
The answer lies in government policy, in a combination of fiscal policy and financial liberalisation which has put upward pressure on interest rates and affected the structure of government borrowing. Two financial liberalisation measures of the early 1990s have been of special significance in terms of government borrowing.
 
The first was the decision to reduce and eventually to do away with deficit financing as a means of financing the fiscal deficit. It is impossible to justify this in rational economic terms, especially given the widespread recognition that some amount of deficit financing (which is the cheapest form of borrowing available to the government) has no inflationary implications. The second was the reduction of the Statutory Liquidity Ratio, which was already mentioned.
 
Both of these measures had the effect of forcing the government into more expensive open market borrowing, which in turn has been a significant cause of the increase in the interest burden of the Central Government. Meanwhile, the increasing resource crunch faced by the State Governments has also forced them into more market borrowing on even more expensive terms, since they are seen as less preferred borrowers than the Central Government.
 
Indeed, while many complain that the problem is that of the past burden of public debt, a major problem is actually that of higher interest rates on public borrowing. These have contributed to a situation which is now perilously close to that of Ponzi finance, in which the government is borrowing mainly in order to pay interest.
 
With this background, the interest rate structure of Central Government debt becomes absolutely crucial in determining the overall level of interest rates. While interest rates on government debt have been reduced in the recent past, real rates remain high. It could even be suggested that these high real interest rates provided by the government have become necessary to shore up the banking system in the current recessionary atmosphere.
 
The problem is that this is not just an issue of fiscal and monetary management. It amounts to a huge burden on present and future taxpayers and potential recipients of public services which are cut because of resource constraints, given the large drain on the public exchequer because of interest payments.
 
This need to maintain high real interest rates in turn becomes necessary because the other aspect of financial liberalisation has meant that the government must necessarily be concerned with the need to attract or maintain capital in the country and prevent capital flight. Thus financial liberalisation, far from reducing real interest rates, has been the major contributory factor to their remaining at high levels.