Even if RBI cuts in December, transmission not certain
The collapse in CPI inflation, from 5.1% in August to 4.3% in September, many economists argue, can even lead to a December CPI of less than 4%, prompting another RBI rate cut since inflation will be much lower than the central bank’s projected March 2017 projection of 5%. One of them, Pranjul Bhandari of HSBC, even argues that the steep fall in food inflation—central banks normally ignore food inflation and concentrate on core inflation—has a structural feel to it since it follows some state governments undertaking food distribution reforms, and also that inflationary expectations are conditioned by the impact of a few crops like pulses whose prices have now come off rapidly due to the good monsoon. Should RBI actually cut rates in December, the important question is whether there will be any transmission—the last cut of 25bps, for instance, has not resulted in any bank cutting base rates. In which case, instead of pitching for another rate cut, the central government will do well to focus on ways to improve transmission.
Certainly the high levels of NPAs and the absence of meaningful demand for credit means that banks don’t feel the need to cut rates—higher rates also allow them to repair their fragile balance sheets. An important issue that banks bring up is their inability to re-price deposits fast, and in the absence of this, they cannot lower rates. Critical in this context is the small savings rates that are a big competition for banks—and despite promising to cut here, the government has been tardy. Between now and March, when the government first said it would reset rates every quarter, GSec rates have fallen 70 bps but rates on small savings have fallen just 10 bps. Which means that, for instance, PPF rates are still a high 8% while those on the Sukanya Samriddhi Scheme are 8.5% and those on the EPFO are still higher at 8.8%. While it is true there is a cap of R1.5 lakh per year on PPF investments, the rate is sufficiently high to pose a threat to banks—more so when you consider even interest earned on PPF is tax free. While the government can argue the PPF and such schemes are long-term in nature as compared to bank deposits, 5-year postal deposits offer 80bps higher rates than similar-tenured bank deposits. If the government is looking for transmission, it has no option but to make some aggressive cuts in small savings rates, including lowering spreads on them and reducing the tax arbitrage vis-à-vis bank deposits.