The minutes of the monetary policy committee indicate that there is a majority view that policy, henceforth, will target growth. This means that there will be a tendency for interest rates to come down even further over time. The repo rate was reduced by 25 bps in the Feb policy, and it is expected there could be two more cuts during the course of the year, though the timing will have to be aligned with the inflation scenarios. It has been assumed that inflation will keep trending downwards, and a normal monsoon would be the norm this year too. More importantly, core inflation has been low and stable, which has given more confidence to the committee to take this stance.
But an interesting observation is that post the policy announcement, there have been few moves by banks to lower the deposit rate as well as the MCLR (marginal cost lending rate). The EBLR (external benchmark lending rate), which holds for individual loans as well as those to MSMEs, should ideally have come down by 25 bps. However, this has not necessarily been the case, and several banks have chosen not to do so and increased the mark-up or spread over the repo rate. From the point of view of borrowers, rates have remained virtually unchanged.
The main issue is deposit rates. Banks have already been challenged all through the year in terms of garnering deposits. The relatively better returns in the capital market have caused some migration of savings to mutual funds. Those with higher risk appetites have invested directly in equities. This being the case, banks would be reluctant to lower deposit rates lest households move further away from deposits. This is the puzzle for bankers where liquidity is an issue. The present situation is characterised as one where growth in credit is steady, but the same cannot be said about deposits. The RBI has been using various techniques to infuse liquidity into the system, including VRR (variable rate repos), open market operations (OMO), and forex swaps. Deposits growth is the crux. If they do not grow, then it is hard for banks to lower their deposit rates.
This has affected the MCLR, which is calculated using a formula based on the marginal cost of funds. If the deposit rate does not come down, the average cost of deposits would remain unchanged, in which case the MCLR remains unchanged. This is why few banks have changed their MCLR.
This would be a thought for the Monetary Policy Committee going forward. While there seems to be some ideological consensus on further lowering the repo rate, the transmission would be in the hands of the banks. In fact, it can be said that in case there was stable liquidity in the system, the rate cut would have been translated to deposits and lending rates. The issue in banking is that when the repo rate changes, all loans are to be repriced at a lower or higher rate. However, in the case of deposits, it is only incremental deposits that get re-priced and hence banks do tend to face pressure on margins in a declining interest rate regime. Transmission of policy rates has always been an issue flagged by the RBI even when there was an upward cycle in the repo rate. The RBI had commented that transmission was still not complete and, hence, the stance was unchanged at ‘withdrawal of accommodation’ in successive policies.
In fact, in retrospect, it can be argued that the repo rate cut could have come after the liquidity situation was stabilised in the system. March is a crucial month for banks. There is the last instalment of advance tax payments made by companies, which will peak by the 15th of the month. Then there are the GST payments which flow post the 20th. And last, the credit growth tends to increase towards the end of the month as banks set about meeting their targets.
Therefore, banks may not be too keen to lower their deposit rates at this point in time. Further, to the extent individuals are following the old tax scheme of taking advantage of exemptions, there would be a year-end rush to save in instruments such as PPF. All this would put some pressure on growth in bank deposits. Any which way, there will be pressure on both deposits and credit. In such a situation, there would be several interventions from the RBI to stabilise liquidity in the normal course of activity.
From the point of view of individuals, however, it can be assumed that interest rates have peaked and there would be few possibilities of banks raising deposit rates. The exceptions could be in certain tenure brackets where banks need to rebalance their portfolio. This could, hence, be the best time to book fixed deposits with banks, depending on the appetite of individuals.
The signalling on lending is also in a single direction. Rates would tend to move southwards in the coming months. As most loans are on floating rates, there would be benefits along the way even though the MCLRs may not have been altered presently. This may not happen immediately and will work through over the next couple of quarters. At any rate, the degree of reduction in bank rates (deposit and lending rates) tends to be lower than that of the repo rate. Therefore, even a 75 bps cut in the repo rate this year would probably lower the deposit rates by around 30-40 bps.
The present ideology of lowering the repo rate is based on an economic theory which says that as interest rates come down, people borrow more to consume more or invest more, which in turn leads to higher growth. The government has already worked its way through the budget to provide an impetus to both consumption (by cutting taxes for individuals) and investment (through higher capex). Monetary policy will now be supporting this effort through the next set of rate cuts.
The author is Chief Economist, Bank of Baroda and author of ‘Corporate Quirks: The Darker Side of the Sun’. Views are personal
