After the rate cut, what? PDF Print E-mail
Tuesday, 07 February 2017 00:41
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Shobhana's edit

Even if RBI cuts repo, expect a limited rise in borrowing


After the admirable restraint shown by the finance minister in reining in the fiscal deficit for FY18 at 3.2% of GDP, at a time when growth badly needed a push, RBI should have absolutely no reason to complain. Indeed, the lowering of the net borrowing target by R20,000 crore for FY18 means there is even less pressure on interest rates. The government’s fiscal discipline and the fact that inflation remains reasonably benign should be comforting for RBI whose monetary policy committee (MPC) meets today to review monetary policy. However, there are niggling worries in that inflation might inch up in sync with prices of crude oil and other commodities. Nevertheless, the rise in prices should be contained within 5.5% in 2017 which is probably why there’s widespread expectation of a 25 basis points cut in the repo to 6%.

Should that materialise, it will no doubt lower the cost of wholesale borrowings for banks. But a cut by RBI, apart from signalling its comfort with inflation and fiscal discipline, can do little else at this point. Thanks to a dramatic drop in the cost of retail deposits, banks have already lowered their incremental lending rates—between June 2016 and now, State Bank of India’s (SBI) MCLR (marginal cost of funds rate) for a one-year tenure has come off by 115 basis points to 8%. However, the lower rates have not succeeded in stimulating any meaningful demand for credit. Loans to companies and individuals are growing at 5-5.5% reflecting unwillingness on the part of companies to expand capacity at a time when the demand outlook remains hazy and there is considerable surplus capacity.

However, the sharp drop in the yield on the benchmark bond—nearly 110 bps over the last eight months—has resulted in a fall in yields and rise in volumes in the corporate bond market. Ostensibly, banks are not too perturbed at some of the action having shifted to the bond market; it’s possible they are participating in some of the issuances. This is not to say there is full transmission since the base rate—the rate to which the bulk of the loans are pegged—has barely moved. That’s because the demand environment is sluggish and therefore a cut is unlikely to deliver a strong demand for loans; in other words, there will be no jump in volumes to compensate for the loss in price. Moreover, at a time when the clean-up process isn’t over and sizeable provisions need to be made for impaired loans, lenders are unwilling to give up even a rupee. It must be remembered that bigger lenders can always lure a corporate customer, if they so wish, by giving up a part of the spread. Banks need to be prodded into lowering the base rate because that could resuscitate smaller companies badly in need of a break. It’s possible that a repo cut might prompt them to do so, but one can’t bet on it.


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