Pass rate cut gains to borrowers

Reserve Bank of India Governor Raghuram Rajan may have disappointed the stock market,
which plunged by over 500 points, after the announcement of the credit policy on April 5, but he remains bang on target to lower the cost of borrowing. The problem is, the discourse in the run-up to the credit policy is so obsessed with the repo rate – whether it would be 50 basis points or 25 basis points – that the rest of the crucial issues are lost sight of. On the other hand, the governor was more than forthright in conveying his message, which is that the interest rates are a function of a combination of factors and not just the benchmark overnight policy rate, which has now been reduced by 25 bps to 6.5%. Continuous cuts in
the repo would not be of much use if the banks do not follow it with equal sincerity or find other factors coming in the way of transmission of the lower rates. Not more than half of the 150 bps reduction in the RBI’s short-term lending rates effected since January 2015 has been passed on to the borrowers, who continue to pay hefty EMIs for their home or car loans.

Banks, too, had merit in their argument on why they were not able to follow the trajectory set by their regulator. They were competing for deposits from the same market where the rates on the government’s small saving schemes were on the higher side. Thankfully, these rates have now been adjusted. But even if this problem is taken out of the way, the banks are facing tight liquidity, finding it hard to attract deposits while the credit growth had started picking up somewhat. Rajan has announced key systemic changes to boost cash at the disposal of the banks. These include reducing the minimum daily maintenance of the cash reserve ratio from 95% to 90% and progressively lowering the average liquidity deficit in the system to near neutrality. “The past rationale for keeping the system in significant average liquidity deficit no longer is as compelling, especially when the policy stance is intended to be  accommodative,” the policy document stated.

There is yet another broad message in the way the RBI and the Finance Ministry have been handling the growth-versus inflation conundrum. There seems to be a good mutual understanding to reach the common goal. The policy takes note of the government’s
“effective supply side measures keeping a check on food prices and (its) commendable commitment to fiscal consolidation.” In the process, banks have been provided a perfect stage for lowering the interest rates.