Depositors rejoice, borrowers flinch

Deposit/lending rates are unlikely to see sharp changes in the near term

Until a few weeks back, rate hikes by the RBI and increase in deposit and lending rates by banks seemed imminent. But that was before RBI Governor Urjit Patel resigned and the liquidity situation remained tight. With the new Governor, Shaktikanta Das stepping in, expectations of rate cuts have gained ground.

Also, the RBI opening the liquidity tap by ramping up the pace of open market operations (buying of government bonds) has led to a sudden slide in G-Sec yield. All of this has made it difficult to predict the road ahead and the New Year may ring in more uncertainty. That said, deposit/lending rates are unlikely to see sharp changes in the near term.

On the rise

While the central bank began hiking repo rate only from this June, concerns over rising inflation and tightening of global liquidity had led to a sharp up move in the yield on 10-year government bonds, much before the RBI’s actions. Taking cues from the bond market, banks also started raising deposit and lending rates since January.

Deposit rates have gone up by 50-75 basis points on an average (even as high as 90-100 bps in some cases) since January. Since deposit rate increases immediately reflect on banks’ cost of funds under MCLR, hikes in lending rates have also been quicker and sharper.

Banks’ benchmark lending rate — one-year MCLR — has gone up by 25-35 bps on an average to as high as 60-70 bps in a few banks this year. Until last week, deposit rates in the two to three-year tenure have been in the 6.75-7 per cent range (best rate of 8.05 per cent offered by a handful). One-year MCLR is around the 8.5-8.8 per cent mark in most banks, but a few also have MCLR upwards of 9.75 per cent.

It’s interesting to note that while banks have been raising fixed deposit and lending rates since January, they have not tinkered with savings deposit rate which they had slashed suddenly in 2017. The reduction in the low-value savings deposit rate to 3.5 per cent (from 4 per cent) continues. Driven by weak credit off-take and rising bad loans, banks have been reluctant to raise rates on savings deposits, as even a 50 bps hike could eat into their margins.

Clouded outlook

The RBI last hiked repo rate in August this year. But pressure on banks’ resources led them to continue hiking deposit rates and lending rates to protect margins.

While the RBI had (under Patel) lowered its inflation projection substantially for the second half of the fiscal, possible risks from fiscal slippages, reversal of unusually low food prices and increase in non-food inflation, had kept open the possibility of further rate hikes.

In the past two weeks, however, expectations of rate cuts have risen. While the very low food inflation and the new Governor taking over the reins at the RBI have kindled hopes of rate cuts, sticky non-food inflation and rising fiscal deficit worries, in particular, can be dampeners. On the liquidity front, the RBI scaling up open market operations (buying of government bonds of ₹50,000 crore each in December 2018 and January 2019) has soothed the bond market. In the past two weeks, yield on 10-year G-Sec has fallen by 20 bps to 7.2 per cent levels. This could keep rate hikes by banks under check.

It is, thus, uncertain how rates will pan out in 2019. In the near term, however, there may not be sharp changes in deposit and lending rates. For now, depositors should opt for shorter duration two to three-year deposits. This will ensure that they lock into the best rates, while also offering them leeway to latch on to better rates when deposit rates move up.

Borrowers should shop for best rates, as lending rates are unlikely to fall sharply, even if the RBI cuts its policy rate. For borrowers, though, what is more important is the RBI mandating banks to peg their lending rates on new floating rate personal or retail loans (and loans to micro and small enterprises) from April 1, 2019, to external benchmarks. This should ensure more transparency in fixing loan rates and better transmission of policy rates. Contours of the structure, when finalised, will be critical for borrowers.

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