Viewpoint| Lower Rates To Help Consumers, Hurt Depositors

The headlines would have be hitting you since noon: that the Reserve Bank (RBI) has cut rates by 25 basis points, that the Monetary Policy Committee (MPC) has changed its stance from ‘neutral’ to ‘accommodative’ and that you can look forward to lower EMIs in the future.

But let’s dive a bit deeper into the monetary policy and understand what these moves mean for you and me – the retail investor.

The Monetary Policy Committee (MPC), which decides interest rates, has reduced the repo rate from 6 per cent earlier to 5.75 per cent. Repo rate is the rate at which Banks avail of liquidity from the RBI. The repo rate the starting point of the needle of interest rates in the economy. Hence, this is the signal for interest rates in the economy; when the RBI wants interest rates to move up, the MPC would raise the repo rate. The other aspect mentioned above is change of stance. When the stance changes from neutral to accommodative, it implies that the MPC would have a bias towards reduction of repo rate in the future, at the slightest opportunity.

Will lower rates get transmitted?

Now the big question is transmission of the rate cuts done so far, totalling 75 basis points this year. Only when the RBI’s signal is transmitted to the real economy, i.e., banks reduce deposit and lending rates, the purpose would be fulfilled. There was a practical issue so far due to which banks did not ease deposit and lending rates to any meaningful extent. The banking system’s liquidity was tight. The rate at which loan off-take from banks has been increasing is higher than the pace at which deposits in banks has been increasing. Due to this mismatch, Banks were not really in a position to reduce deposit and lending rates. If they did, loans would become more attractive, leading to more demand, and deposits would become less appealing, resulting in even lower deposit growth. As a consequence, the first two rate cuts of February and April did not have much impact on the real economy.

However, now, there is a positive change in the scenario. Due to the national elections, two things were happening. One, money was moving out of the banking system as during/before elections, the cash circulation in the economy goes up as there are certain cash-based transactions. This was one of the reasons for relatively lower growth in Bank deposits. The other thing was lower Government expenditure. Since there is a lead time between Government expenditure and its intended impact, a chunk of money was lying in the Government’s account with the RBI, away from the banking system. Now, Government spending has started post elections. Over the past few days, thankfully, the banking system liquidity has moved from deficit (i.e., tight liquidity) to surplus.

More steps from the regulator

The RBI has constituted a Working Group to review the liquidity management framework and suggest measures, among others, to (i) simplify the current liquidity management framework; and (ii) communicate the objectives of liquidity management by the Reserve Bank. In the post-policy media conference, the Governor committed to maintaining adequate liquidity in the future. Given these developments, as long as the banking system’s liquidity is positive or is in surplus, the situation would be more conducive for the transmission of the 0.75 per cent rate cut done by the RBI. Banks base their fresh loan rates on the Marginal Cost-based Lending Rate (MCLR), which is a function of fresh deposits, as distinct from historical deposit rates. This is where the rate for fresh deposits become relevant.

Though the time frame is anybody’s call, we can look forward to lower rates in the economy. It will be beneficial for (i) business persons, as loan rates would be cheaper (ii) for consumers, as EMIs would be easier and higher consumption would drive the economy.

However, it will be unfavourable for senior citizens dependent on Bank deposits. Given that the MPC’s stance is accommodative, we may look forward to further policy rate easing.


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