RBI’s rate cut may not lead to significant reduction in lending rates

The RBI delivered on broad expectations of a repo rate cut , paving the way for lower lending and deposit rates in the coming months. While a few banks have trimmed their lending rates since the RBI’s February rate cut, liquidity constraints and a sticky 10-year G-Sec yield have impeded transmission. Hence, lending rate cuts have been little and few.

While the RBI cutting the repo rate by another 25 bps in its latest policy (50 bps in all this year so far) can nudge more banks to trim lending rates, a high credit-deposit ratio, high currency in circulation, persisting pressure on banks’ deposit growth and fiscal concerns exerting pressure on bond yields -- will cap the extent of lending rate cuts by banks. Hence, significant reduction in deposit and lending rates is unlikely. Also the RBI had proposed use of external benchmarks to peg the lending rates of retail/ personal loans and loans to micro and small enterprises, to improve transmission. This has been deferred for now.

What is important to note is that the RBI has not changed its stance from neutral to accommodative as was expected in the market. This will also temper banks’ rate cuts. Nonetheless, given the uncertainty on future inflation trends and fiscal worries, RBI’s status quo on stance and not going overboard on a rate cut (50 bps repo rate cut expectations had been doing the rounds) are hugely welcome.

In a nutshell, depositors can heave a sigh of relief as deposit rates are unlikely to move sharply lower in the near term. For borrowers, a reprieve will come only in fits and starts.

Small moves

Since the RBI’s repo rate cut of 25 bps in February, banks have hardly cut deposit rates, owing to persisting pressure on deposit growth. Deposit rates for public sector banks are already significantly lower than most private sector banks, offering less leeway to trim rates.

On the lending rate front, however, few banks have trimmed their benchmark one-year MCLR (marginal cost of funds lending rates), but just by 5-10 bps. Leading banks such as HDFC Bank and SBI are yet to cut their MCLR (no action until April 3).

While the RBI’s Thursday policy rate cut of another 25 bps may nudge more banks to trim lending rates, widespread and substantial cuts are unlikely. Even though liquidity has improved thanks to recent foreign inflows, RBI’s open market operations (OMOs of around Rs 2.9 lakh crore in FY19) and recent dollar swap (injecting Rs 34,500 crore) may not be enough to ensure smooth monetary policy transmission. Higher currency in circulation, a high credit-deposit ratio and fiscal worries will impede transmission, implying lower lending rate cuts by banks. While the RBI has announced a second dollar swap auction on April 23, which can ease up liquidity pressure, it may not be enough to improve transmission.

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