VIEWPOINT | RBI Has Done The Due, Now Over To Transmission

Come any RBI Policy Review, and all eyes are on the extent of reduction (or increase) in repo rate like the climax of a thriller movie. This is natural because the repo rate is the pivot that moves interest rates across the economy. When there are obvious indicators like benign inflation (much lower than the RBI’s target of 4%), central banks globally reducing rates, there are talks of recession and the US yield curve is inverted (which is a classic indicator of recession). The staring at the review outcome was more intense. Twenty five basis point reduction in repo rate was almost given as per expectations on the street. Some expected a higher rate reduction of 50 basis points, and some others expected a change of stance on policy rates from neutral to accommodative, which would open up the door for further rate reduction.

The RBI did oblige with a 25-bps cut in repo rate from 6.25% to 6%, but it was perceived as a non-event as the stance on rates was maintained at neutral. This means the RBI would reduce interest rates only if warranted. In the monetary policy committee (MPC) comprising six members, voting was 4:2 for rate cut by 25 bps, and 2 members favoured status quo. The voting was 5:1 for maintenance of neutral policy stance while one member wanted change of stance to accommodative. There were certain other announcements in the review. One of these is that the proposed benchmarking of floating rate retail loans to an external benchmark is being put off for the time being due to certain practical difficulties. It means floating rate loans continue to be benchmarked to the bank’s own parameter.

Going forward, there is scope for at least one more rate cut of 25 basis points, given the benign inflation, question marks on our GDP growth rate and global tailwinds of low or even negative interest rates. However, the challenge today is different: the transmission of rate cuts has already been executed. Credit off-take from banks is growing at a buoyant pace. Deposits in banks are growing as well, but at a slower pace. The implication is that the demand for funds is higher than the supply.

Funds would be borrowed by the government to bridge budget deficits and by corporates for funding projects and working capital. Though the RBI wants the transmission of rate cuts to the real economy, i.e. rates of loans taken by you and me, and they are meeting bankers on the progress of transmission; the RBI is not in a position to put much pressure. Since February 7, 2019 – the date of the previous rate cut of 25 bps, banks have reduced interest rates by 5 to 10 bps only.

To the extent the 50 basis points of rate cut, including the one on February 7, is passed on; it would mean lower returns on bank deposits and lower interest on loans taken by industrialists and by people like you and me. In the recent past, to fund the demand for loans, some banks sold holdings of government securities which were in excess of SLR requirements. In the financial year 2018-19, the RBI purchased a hefty amount of government securities under Open Market Operations (OMO) – almost Rs 3 lakh crore. This year, it remains to be seen how much OMO purchases the RBI does. To the extent it is lower than the previous year and banks are selling G-Secs over and above SLR requirements, it would put pressure on yield levels in the secondary market to fund the loan demand. This would be inimical to transmission of lower interest rates.

Net-net, there is scope for further rate cut by the RBI. But, before taking the call on the next move, it would probably pause and take stock of how much is being passed on



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