Govt may pay interest subsidy directly to borrowers

The government is planning to replace the interest subvention schemes, where the burden falls on banks, and replace them with back-end interest subsidies in order to improve transmission of monetary policy actions.

Under the interest subvention scheme, the borrower gets cheaper credit up front, with the government compensating the lender (mostly public sector banks) later. The back-end subsidy scheme involves direct payment of the subsidy to the beneficiary at a later date after the borrower takes loans at market rate.

''We need to revisit our interest subvention schemes and replace them with back-end interest subsidies that do not interfere with marginal lending rates and yet have the same effect on loan repayments as interest subventions,'' finance secretary Ratan Watal said on Monday.

The interest subvention scheme is currently applicable on select export credit, farm loans, housing and education loans.

The government expects interest rates to come down, which would limit the need for subventions.

In his remarks at the closing session of the second conference with state finance secretaries, Watal also stressed the need to remove distortions in the new system of setting marginal lending rates, started from 1 April.

He also justified the government move to quarterly review the return on small savings in line with G-sec yields, saying the decision to rationalise the small savings rate will help households get a ''better deal'' on lending rates.

While pointing out that monetary policy transmission cannot be left solely to the Reserve Bank of India, he, however, said such policy interventions may often distort the transmission of monetary policy actions.

Analysts say the impact of the back-end interest subsidy will depend on how it is packaged, adding that it would also have an effect on bans as well as the user industries.

A committee set up by the RBI on the `Medium-term Path on Financial Inclusion' had, in December 2015, recommended phasing out the interest subvention scheme and ploughing the subsidy amount into a universal crop insurance scheme for small and marginal farmers.

It felt that the scheme had distorted the agricultural credit system and seems to have impeded long-term investment.